Scribd Logo
Upload

Welcome to Scribd!

  • 30 views

    Wa 6

    Uploaded by

    Muhammad nasir
    This document contains the details of Weekly Assignment #6 for the Business Finance-II course, including 5 questions related to capital structure and the tradeoff theory. Mr. Harris and Ms. Broske are analyzing the optimal capital structure for Boisjoly Company using the MM framework and WACC minimization approach, respectively. The document also provides a case study about the capital structure decision facing Zombie Inc. and the impact on shareholder Ms. Spears' cash flows under different scenarios.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd

    Wa 6

    Uploaded by

    Muhammad nasir
    30 views2 pages
    This document contains the details of Weekly Assignment #6 for the Business Finance-II course, including 5 questions related to capital structure and the tradeoff theory. Mr. Harris and Ms. Broske are analyzing the optimal capital structure for Boisjoly Company using the MM framework and WACC minimization approach, respectively. The document also provides a case study about the capital structure decision facing Zombie Inc. and the impact on shareholder Ms. Spears' cash flows under different scenarios.

    Original Title

    WA-6

    Copyright

    © © All Rights Reserved

    Available Formats

    DOCX, PDF, TXT or read online from Scribd

    Did you find this document useful?

    Is this content inappropriate?

    This document contains the details of Weekly Assignment #6 for the Business Finance-II course, including 5 questions related to capital structure and the tradeoff theory. Mr. Harris and Ms. Broske are analyzing the optimal capital structure for Boisjoly Company using the MM framework and WACC minimization approach, respectively. The document also provides a case study about the capital structure decision facing Zombie Inc. and the impact on shareholder Ms. Spears' cash flows under different scenarios.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    30 views2 pages

    Wa 6

    Uploaded by

    Muhammad nasir
    This document contains the details of Weekly Assignment #6 for the Business Finance-II course, including 5 questions related to capital structure and the tradeoff theory. Mr. Harris and Ms. Broske are analyzing the optimal capital structure for Boisjoly Company using the MM framework and WACC minimization approach, respectively. The document also provides a case study about the capital structure decision facing Zombie Inc. and the impact on shareholder Ms. Spears' cash flows under different scenarios.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    of 2

    Business Finance-II (FIN507)

    Weekly Assignment # 6

    Instructor: Sana Tauseef


    Semester: Spring 2023
    Due Date: March 26, 2023, 11 p.m.

    1. Other things being the same, firms with relatively stable sales are able to carry
    relatively higher debt ratios. True or false? Explain.
    (4-5 lines)

    2. If a firm went from zero debt to successively higher levels of debt, why would you
    first expect its stock price to rise, then hit a peak and then begin to decline?
    (4-5 lines)

    3. Why do companies prioritize their sources of financing as explained by the


    Pecking Order Theory? (4-5 lines)

    4. The Boisjoly Company currently has no debt. An in-house research group has
    just been assigned the job of determining whether the firm should change its
    capital structure. Because of the importance of the decision, management has
    also hired the investment banking firm of Stanley Morgan & Company to conduct
    a parallel analysis of the situation. Mr. Harris, the in-house analyst, who is well
    versed in modern finance theory, has decided to carry out the analysis using the
    MM framework. Ms. Broske, the Stanley Morgan consultant, who has a good
    knowledge of capital market conditions and is confident of her ability to predict
    the firm’s debt and equity cost at various levels of debt, has decided to estimate
    the optimal capital structure as that structure which minimizes the firm’s weighted
    average cost of capital. The following data are relevant to both analyses:
    EBIT = $4 million per year, in perpetuity
    Federal-plus-state tax rate = 40%
    Dividend payout ratio = 100%
    Current required rate of return on equity= 12%

    The cost of capital schedule predicted by Ms. Broske follows:


    At a debt level of (Millions of Dollars)
    $0 $2 $4 $6 $8 $10 $12 $14
    Interest rate (%) - 8.0 8.3 9.0 10.0 11.0 13.0 16.0
    Cost of Equity (%) 12.0 12.25 12.75 13.0 13.15 13.4 14.65 17.0

    Mr. Harris estimated the present value of financial distress costs at $8 million.
    Additionally, he estimated the following probabilities of bankruptcies:
    At a debt level of (Millions of Dollars)
    $0 $2 $4 $6 $8 $10 $12 $14
    Probability of financial distress 0 0 0.0 0.07 0.1 0.17 0.47 0.90
    5 0

    a. What level of debt would Mr. Harris,Ms. Broske recommend as optimal?


    b. Comment on the similarities and differences in their recommendations.

    5. Zombie Inc., a prominent consumer products firm, is debating whether or not to


    convert its all-equity capital structure to one that is 40% debt. Currently, there are
    1,000 shares outstanding and the price per share is $70. EBIT is expected to
    remain at $7,000 per year forever. The interest rate on new debt is 7% and there
    are no taxes. All MM assumptions apply.

    a. Ms. Spears, a shareholder of the firm owns 100 shares of stock. What is
    her cash flow under the current capital structure, assuming the firm has a
    dividend payout rate of 100%?
    b. What will Ms. Spear’s cash flow be under the proposed capital structure of
    the firm? Assuming that she keeps all 100 of her shares.
    c. Suppose Zombie does convert, but Ms. Spears prefers the current all-
    equity capital structure. Show how she could unlever her shares of stocks
    to recreate the original capital structure.
    d. Suppose Zombie does not convert, but Ms. Spears prefers the proposed
    capital structure. Show how she could lever her shares of stocks to create
    the new capital structure.

    You might also like