Exercises from Financial Management Book, Chapter14

Solutions to Exercises Session 2 (Capital Structure) 14-1QBE = pic QBE = pic QBE = 500,000 units. 14-4From the Hamada equation, b = bU1 + (1 T)(D/E), we can wager bU as bU = b/1 + (1 T)(D/E). bU = 1. 2/1 + (1 0. 4)($2,000,000/$8,000,000) bU = 1. 2/1 + 0. 15 bU = 1. 0435. 14-8Facts as given received capital structure 25% debt, 75% fair play rRF = 5% rM rRF = 6% T = 40% rs = 14%. tonicity 1Determine the flyings current beta. rs= rRF + (rM rRF)b 14%= 5% + (6%)b 9%= 6%b 1. 5= b. tone 2Determine the quicks unlevered beta, bU. bU= bL/1 + (1 T)(D/E) 1. 5/1 + (1 0. 4)(0. 25/0. 75) = 1. 5/1. 20 = 1. 25. Step 3Determine the firms beta under the new capital structure. bL= bU1 + (1 T)(D/E) = 1. 251 + (1 0. 4)(0. 5/0. 5) = 1. 25(1. 6) = 2. Step 4Determine the firms new cost of equity under the changed capital structure. rs= rRF + (rM rRF)b = 5% + (6%)2 = 17%. 14-9a. a. If net income = $1,000,000 and dividend pay forbidden proportionality = 40%, then the total amount of dividend paid in Year 0 was 40% x $1,000,000 = $400,000. Therefore, the current dividend per share, D0, = $400,000/200,000 shares = $2. 0. D1 = $2. 00(1. 05) = $2. 10. Therefore, P0 = D1/(rs g) = $2. 10/(0. 134 0. 05) = $25. 00. b. Step 1 consider EBIT before the recapitalization The firm is 100% equity financed, so there is no interest expense. (EBIT = EBT NI = EBT Taxes = EBT EBT(T) = EBT (1-T) ? EBIT = EBT = NI/ (1-T) = $1,000,000/(1 T) = $1,000,000/0. 6 = $1,666,667. Step 2 project net income after the recapitalization EBT = EBIT Interest expense = $1,666,667 11%($1,000,000) $1,666,667 $110,000 = $1,566,667 NI = EBT (1T) = $1,566,667(. ) = $934,000 Step 3Calculate the number of shares outstanding after the recapitalization The company takes out a $1,000,000 to repurchase stock currently prices at $25. Number of shares after recapitalization 200,000 ($1,000,000/$25) = 160,000 shares. Step 4Calculate D1 after the recapitalization Given the 40% payout ratio D0 = 40%($934,000/160,00 0) = $2. 335. D1 = $2. 335(1. 05) = $2. 45175. Step 5Calculate P0 after the recapitalization P0 = D1/(rs g) = $2. 45175/(0. 145 0. 05) = $25. 8079 ( $25. 81.