What is the after-tax cost of debt if the tax rate is 34%? (5 pts) c. Explain what other methods you could have used to find the cost of debt for AirJet Best Parts Inc.(10 pts) d. Explain why you should use the YTM and not the coupon rate as the required return for debt. (5 pts) 2. Compute the cost of common equity using the CAPM model. For beta, use the average beta of three selected competitors.
In our calculation, we multiplied the shares outstanding by the current market price of the stock. Our equity figure came out to (271.5 x $42.09) $11,427.4. This is significantly more than Joanna’s book value estimate of $3,494.5. We believe that Joanna mistakenly used the book value of equity rather than the market value of equity in her WACC calculations. This significantly impacts the equity to debt ratio used in the WACC calculation.
Week 5 Problem 3 Carri Gradisca FIN/370 – Finance for Business August 6, 2012 Professor Shadi Sifain Week 5 Problem 3 A firm’s current balance sheet is as follows: Assets: $100 Debt: $10 Equity: 90 a. What is the firm’s weighted-average cost of capital at various combinations of debt and equity, given the following information? Debt/Assets | After-Tax Cost of Debt | Cost of Equity | Cost of Capital | 0% | 8% | 12% | 12.00% | 10 | 8 | 12 | 11.60% | 20 | 8 | 12 | 11.20% | 30 | 8 | 13 | 11.50% | 40 | 9 | 14 | 12.00% | 50 | 10 | 15 | 12.50% | 60 | 12 | 16 | 13.60% | b. Construct a pro forma balance sheet that indicates the firm’s optimal capital structure. Compare this balance sheet with the firm’s current balance sheet. What course of action should the firm take?
Debt and Equity Weights The first mistake in Joanna’s calculation is that the weights of Nike’s debt and equity should be based on the market value rather than book value mixes of Nike’s debt and equity. Since market value weights are more relevant to measure cost of capital in the present time, calculation based on historical book value weights is inappropriate and misleading. Noticed the market value of Nike’s debt is very close to its book value, it is the market value of equity that need to be used to calculate the weights.
B. After tax return on capital Return on Capital for Nike Apparel: |Year |EBIT (1-t) |Average BV |ROC | |1 |0 |1500 | | |2 |0 |2310 | | |3 |-87 |2489 |-3.50% | |4 |9 |2258 |0.40% | |5 |104 |2085 |4.98% | |6 |199 |1959 |10.16% | |7 |229 |2074 |11.02% | |8 |336 |1999 |16.81% | |9 |436
• Significant debt issue is a concern as it is risky and in conflict with the company’s culture and managerial of low-risk attitude. Hence, 20% debt-to-capital restructure is recommended as it is not significant amount as opposed to other alternatives. • Other effects, including financial distress, signaling, investment and clientele considerations, are difficult to measure but predictable to balance out to a mildly optimistic set of considerations. • An alternative approach is to increase debt in order to use the proceeds to pay dividends, however it is not recommended. In conclusion, if Hill Country were to engage in the leveraged recapitalization, this report would highly recommend the 20% debt-to-capital ratio be used to repurchase shares.
One, the bond performs and you make 35% more. Second, you can lose money because the paper doesn't perform to the full term. It is a riskier choice than par or premium because you’re banking on the fact that the company does well. However, the upside is much better. In my opinion, I believe the risk can be worth it because you can make a lot of money this way.
With these potential benefits, target companies will often agree to be purchased when they know they cannot survive alone. Here the issue is of financing the merger. A firm’s optimal capital structure is that mixture of debt and equity than minimizes its weighted average cost of capital (WACC). Since the after-tax cost of debt is lower than equity for many corporations. It turns out that, while debt reduces a company’s tax liability because interest payments are deductible expenses, increasing amounts of debt raise both the cost of equity capital and the interest rate on debt because of the increasing probability of bankruptcy.
This case discusses the strategy of Dimensional Fund Advisors (DFA) whose investment philosophy particularly focused on research by Fama and French and Banz. They researched how small cap companies tend to outperform large cap companies over time. FDA also created an additional competitive advantage by created trading efficiencies to reduce transaction cost. a). Fama and French found that stocks with high betas did not have consistently higher returns than low-beta stocks and that a high book value to market value was the most important variable related to predicting high stock returns on small cap stocks.