· Complete the following problems from your textbook:
· Pages
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9–513: 14-2, 14-6, and 14-14 (parts a–c).
· Pages 545: 15-1, 15-3, and 15-4.
14-2 OPTIMAL CAPITAL STRUCTURE Terrell Trucking Company is in the process of setting its target capital structure. The CFO believes that the optimal debt-to-capital ratio is somewhere between
20%
and 50%, and her staff has compiled the following projections for EPS and the stock price at various debt levels:
|
Debt/Capital Ratio
|
Projected EPS
|
Projected Stock Price
|
|
20%
|
$3.10
|
$34.25
|
|
30
|
|
3.55
|
36.00
|
|
40
|
3.70
|
35.50
|
|
50
|
3.55
34.00
|
Assuming that the firm uses only debt and common equity, what is Terrell’s optimal capital structure? At what debt-to-capital ratio is the company’s WACC minimized?
14-6
BREAK-EVEN ANALYSIS The Warren Watch Company sells watches for $26, fixed costs are $155,000, and variable costs are $13 per watch.
a. What is the firm’s gain or loss at sales of 9,000 watches? At 15,000 watches?
b. What is the break-even point? Illustrate by means of a chart.
c. What would happen to the break-even point if the selling price was raised to $33? What is the significance of this analysis?
d. What would happen to the break-even point if the selling price was raised to $33 but variable costs rose to $24 a unit?
14-14 WACC AND OPTIMAL CAPITAL STRUCTURE Elliott Athletics is trying to determine its optimal capital structure, which now consists of only debt and common equity. The firm does not currently use preferred stock in its capital structure, and it does not plan to do so in the future. Its treasury staff has consulted with investment bankers. On the basis of those discussions, the staff has created the following table showing the firm’s debt cost at different debt levels:
Elliott uses the CAPM to estimate its cost of common equity, rs, and estimates that the risk-free rate is 5%, the market risk premium is 6%, and its tax rate is 40%. Elliott estimates that if it had no debt, its “unlevered” beta, bU, would be 1.2.
a. What is the firm’s optimal capital structure, and what would be its WACC at the optimal capital structure?
b. If Elliott’s managers anticipate that the company’s business risk will increase in the future, what effect would this likely have on the firm’s target capital structure?
c. If Congress were to dramatically increase the corporate tax rate, what effect would this likely have on Elliott’s target capital structure?
Questions
Easy Problems 1-3
15-1 RESIDUAL DIVIDEND MODEL Altamonte Telecommunications has a target capital structure that consists of 45% debt and 55% equity. The company anticipates that its capital budget for the upcoming year will be $1,000,000. If Altamonte reports net income of $1,200,000 and it follows a residual dividend payout policy, what will be its dividend payout ratio?
15-3 STOCK REPURCHASES Gamma Industries has net income of $3,800,000, and it has 1,490,000 shares of common stock outstanding. The company’s stock currently trades at $67 a share. Gamma is considering a plan in which it will use available cash to repurchase 10% of its shares in the open market at the current $67 stock price. The repurchase is expected to have no effect on net income or the company’s P/E ratio. What will be its stock price following the stock repurchase?
Intermediate Problems 4-6
15-4 STOCK SPLIT After a 5-for-1 stock split, Tyler Company paid a dividend of $1.15 per new share, which represents a 7% increase over last year’s pre-split dividend. What was last year’s dividend per share?
·
Complete the following problems from your textbook:
o
Pages 509
–
513: 14
–
2, 14
–
6, and 14
–
14 (parts a
–
c).
o
Pages 545: 15
–
1, 15
–
3, and 15
–
4.
14
–
2
OPTIMAL CAPITAL STRUCTURE
Terrell Trucking Company is in the process of
setting its ta
rget capital structure. The CFO believes that the optimal debt
–
to
–
capital ratio is
somewhere between 20% and 50%, and her staff has compiled the following projections for EPS
and the stock price at various debt levels:
Debt/Capital Ratio
Projected EPS
Projected Stock Price
20%
$3.10
$34.25
30
3.55
36.00
40
3.70
35.50
50
3.55
34.00
Assuming that the firm uses only debt and common equity, what is Terrell’s optimal capital
structure? At what debt
–
to
–
capital ratio is the company’s WACC minimized?
14
–
6
BREAK
–
EVEN ANALYSIS
The Warren Watch Company sells watches for $26, fixed
costs are
$155,000, and variable costs are $13 per watch.
a.
What is the firm’s gain or loss at sales of 9,000 watches? At 15,000 watches?
b.
What is the break
–
even point? Illustrate by means of a chart.
c.
What would happen to the break
–
even point if the
selling price was raised to $33? What is the
significance of this analysis?
d.
What would happen to the break
–
even point if the selling price was raised to $33 but variable
costs rose to $24 a unit?
Complete the following problems from your textbook:
o Pages 509–513: 14-2, 14-6, and 14-14 (parts a–c).
o Pages 545: 15-1, 15-3, and 15-4.
14-2 OPTIMAL CAPITAL STRUCTURE Terrell Trucking Company is in the process of
setting its target capital structure. The CFO believes that the optimal debt-to-capital ratio is
somewhere between 20% and 50%, and her staff has compiled the following projections for EPS
and the stock price at various debt levels:
Debt/Capital Ratio Projected EPS Projected Stock Price
20% $3.10 $34.25
30 3.55 36.00
40 3.70 35.50
50 3.55 34.00
Assuming that the firm uses only debt and common equity, what is Terrell’s optimal capital
structure? At what debt-to-capital ratio is the company’s WACC minimized?
14-6
BREAK-EVEN ANALYSIS The Warren Watch Company sells watches for $26, fixed costs are
$155,000, and variable costs are $13 per watch.
a. What is the firm’s gain or loss at sales of 9,000 watches? At 15,000 watches?
b. What is the break-even point? Illustrate by means of a chart.
c. What would happen to the break-even point if the selling price was raised to $33? What is the
significance of this analysis?
d. What would happen to the break-even point if the selling price was raised to $33 but variable
costs rose to $24 a unit?
