FIN4131 CAPITAL STRUCTURE
1. Taunton's is an all-equity firm that has 150,000 shares of stock
outstanding. Neal, the financial vice president, is considering borrowing
$220,000 at 8.25 percent interest to repurchase 20,000 shares.
Ignoring taxes, what is the value of the firm?
Value per share = $220,000/20,000 = $11
Firm value = 150,000 × $11 = $1,650,000
2. The Christmas Tree Farms, Inc. currently has 45,000 shares of stock
outstanding and no debt. The price per share is $17.50. The firm is
considering borrowing funds at 7.5 percent interest and using the
proceeds to repurchase 4,000 shares of stock. Ignore taxes. How much
is the firm borrowing?
4,000 × $17.50 = $70,000
3. The Tree House has a pretax cost of debt of 7.9 percent and a return on
assets of 11.7 percent. The debt-equity ratio is 0.50. Ignore taxes.
What is the cost of equity?
RE = 0.117 + [(0.117 - 0.079) × 0.50] = 13.60 percent
4. The Outlet Mall has a cost of equity of 16.8 percent, a pretax cost of
debt of 8.1 percent, and a return on assets of 14.5 percent. Ignore
taxes. What is the debt-equity ratio?
0.17 = 0.145 + [(0.145 - 0.081) × D/E]
D/E = 0.39
5. Brick House Cafe has a 35 percent tax rate and total taxes of $35,280.
What is the value of the interest tax shield if the interest expense is
$16,700?
Interest tax shield = 0.35 × $16,700 = $5,845
6. Forbidden Fruit Extracts expects its earnings before interest and taxes
to be $325,000 a year forever. Currently, the firm has no debt. The cost
of equity is 16.3 percent and the tax rate is 35 percent. The company is
in the process of issuing $2 million of bonds at par that carry a 6.5
percent annual coupon. What is the unlevered value of the firm?
