Suppose that Seattle Health Plans use zero-debt financing. It's operating profit is $1 million, and it pays taxes at a 40 percent rate. It has $5 million in assets and, because it is all equity financed, $5 million equity. The firm's profit, total dollar return to investors, and return on equity under these conditions are listed below. Suppose that the firm is considering replacing half of its equity financing with debt financing that bears an interest rate of 8 percent A) What impact would the new capital structure have on the firm's profit, total dollar return to investors, and return on equity? B) Redo the analysis, but now assume that the debt financing would cost 15 percent. C) Repeat the analysis required for question A, but now assume that Seattle Health Plans is a not-for-profit corporation and hence pays no taxes. Balance Sheets Total Assets $5,000,000 Debt $0 Common stock (=equity) $5,000,000 Total liabilities & equity $5,000,000 Income Statements EBIT $1,000,000 Interest expense $0 Taxable Income $1,000,000 Taxes (40%) 400,000 Net Income (=profit) 600,000 Total dollar return to investors $600,000 ROE 12.0%

Suppose that Seattle Health Plans use zero-debt financing. It's operating profit is $1 million, and it pays taxes at a 40 percent rate. It has $5 million in assets and, because it is all equity financed, $5 million equity. The firm's profit, total dollar return to investors, and return on equity under these conditions are listed below. Suppose that the firm is considering replacing half of its equity financing with debt financing that bears an interest rate of 8 percent A) What impact would the new capital structure have on the firm's profit, total dollar return to investors, and return on equity? B) Redo the analysis, but now assume that the debt financing would cost 15 percent. C) Repeat the analysis required for question A, but now assume that Seattle Health Plans is a not-for-profit corporation and hence pays no taxes. Balance Sheets Total Assets $5,000,000 Debt $0 Common stock (=equity) $5,000,000 Total liabilities & equity $5,000,000 Income Statements EBIT $1,000,000 Interest expense $0 Taxable Income $1,000,000 Taxes (40%) 400,000 Net Income (=profit) 600,000 Total dollar return to investors $600,000 ROE 12.0%

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter3: Evaluation Of Financial Performance

Section: Chapter Questions

Problem 7P

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Seattle Health Plans currently uses zero-debt financing. Its operating profit is $1 million, and it pays taxes at a 40 percent rate. It has $5 million in assets and, because it is all-equity financed, $5 million in equity. Suppose the firm is considering replacing half of its equity financing with debt financing that bears an interest rate of 8 percent. What impact would the new capital structure have on the firm’s profit, total dollar return to investors, and return on equity? Redo the analysis, but now assume that the debt financing would cost 15 percent. Repeat the analysis required for part a, but now assume that Seattle Health Plans is a not-for-profit corporation and hence pays no taxes. Compare the results with those obtained in part a
You are considering investing in Dakota's Security Services. You have been able to locate the following information on the firm: Total assets are $32.6 million, accounts receivable are $4.46 million, ACP is 25 days, net income is $4.83 million, and debt-to-equity is 1.3 times. All sales are on credit. Dakota's is considering loosening its credit policy such that ACP will increase to 30 days. The change is expected to increase credit sales by 6 percent. Any change in accounts receivable will be offset with a change in debt. No other balance sheet changes are expected. Dakota's profit margin will remain unchanged. How will this change in accounts receivable policy affect Dakota's net income, total asset turnover, equity multiplier, ROA, and ROE? Note: Do not round intermediate calculations. Enter your answer in millions of dollars. Round your answers to 2 decimal places. Use 365 days a year. Net income Total asset turnover Equity multiplier ROA ROE million times times % %
Assume that Hogan Surgical Instruments Co. has $3,100,000 in assets. If it goes with a low-liquidity plan for the assets, it can earn a return of 14 percent, but with a high-liquidity plan, the return will be 10 percent. If the firm goes with a short-term financing plan, the financing costs on the $3,100,000 will be 6 percent, and with a long-term financing plan, the financing costs on the $3,100,000 will be 8 percent. a. Compute the anticipated return after financing costs with the most aggressive asset-financing mix. b. Compute the anticipated return after financing costs with the most conservative asset-financing mix.
Blue Cod, Inc., a private firm in the holiday gift industry, is considering a new project. The company currently has a target debt-equity ratio of .35, but the industry target debt-equity ratio is .30. The industry average beta is 1.50. The market risk premium is 8 percent, and the risk-free rate is 6 percent. Assume all companies in this industry can issue debt at the risk-free rate. The corporate tax rate is 40 percent. The project requires an initial outlay of $690,000 and is expected to result in an after-tax EBIT of $110,000 at the end of the first year. The project will be financed at the company's target debt-equity ratio. Annual cash flows from the project will grow at a constant rate of 7 percent until the end of the fifth year and remain constant forever thereafter. What is the NPV of this project? (Keep at least 3 decimal places in intermediate steps. Choose an answer that is closest to yours) $263,770.1 $211,264.8 $291,028.5 $237,186.1
Assume that Hogan Surgical Instruments Co. has $2,700,000 in assets. If it goes with a low-liquidity plan for the assets, it can earn a return of 15 percent, but with a high-liquidity plan, the return will be 11 percent. If the firm goes with a short-term financing plan, the financing costs on the $2,700,000 will be 7 percent, and with a long-term financing plan, the financing costs on the $2,700,000 will be 9 percent. a. Compute the anticipated return after financing costs with the most aggressive asset-financing mix. Anticipated return $ 160,000 b. Compute the anticipated return after financing costs with the most conservative asset-financing mix. Anticipated return $ 40,000 c. Compute the anticipated return after financing costs with the two moderate approaches to the asset-financing mix. Anticipated Return Low liquidity High liquidity
Blue Angel, Inc., a private firm in the holiday gift industry, is considering a new project. The company currently has a target debt-equity ratio of .45, but the industry target debt- equity ratio is .50. The industry average beta is 1.10. The market risk premium is 6.9 percent and the risk-free rate is 4.5 percent. Assume all companies in this industry can issue debt at the risk-free rate. The corporate tax rate is 23 percent. The project requires an initial outlay of $825,000 and is expected to result in a $101,000 cash inflow at the end of the first year. The project will be financed at the company's target debt-equity ratio. Annual cash flows from the project will grow at a constant rate of 5 percent until the end of the fifth year and remain constant forever thereafter. Calculate the NPV of the project. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) NPV
Imagine a firm with one period of operations. In case of a strong economy, the FCF from operations at year 1 will be $2,800. In case of a weak economy, the FCF at year 1 will be $1,800. Both scenarios are equally likely to happen. The risk-free rate is 3% and the equity risk premium is 12% per year. Under these circumstances, if the cost of levered equity is 28%, how much debt financing does the firm use? $1,070 $960 $1,110 $1,000 O $1,040
A company needed ghc 1000 to finance its activities. The firm can financed this expenditure either by bonds or equity. Interest rate on bonds is 10%. The company can earn ghc 160 in good years and ghc80 in bad years. Assuming the firm faces equal probability of good and bad years; i What will be the stream of returns on both bonds and equity if the company chooses the following financing options a 100% equity financing b 50% equity financing c 20% equity financing d 0% equity financing ii Estimate the equity risk associated with each option in (i) iii As an investor who wants to purchase a share in the company, which financing option will make you purchase the stock. Why????
DuraMax Inc. manufactures car radios and reported $ 75 million in operating income last year on revenues of $ 1 billion last year. The firm is all equity funded and you have computed a beta for the firm of 0.80. You have estimated the optimal debt ratio for the firm to be 40% debt, and you expect the firm to have S 20 million in interest expenses at that debt ratio. Using the interest coverage ratio table at the bottom of this page, estimate the cost of capital for DuraMax at the optimal debt ratio. The riskfree rate is 4%, the tax rate is 40% and the equity market risk premium is 4.82%. Interest Coverage Typical default spread 0.35% Ratio Rating AAA > 12.5 9.50 -12.50 AA 0.50% 7.50 - 9.50 6.00 – 7.50 4.50 - 6.00 A+ 0.70% 0.85% 1.00% BBB 1.50% 2.00% 4.00 – 4.50 3.50 – 4.00 BB+
Assume that Hogan Surgical Instruments Co. has $3,400,000 in assets. If it goes with a low-liquidity plan for the assets, it can earn a return of 17 percent, but with a high-liquidity plan, the return will be 13 percent. If the firm goes with a short-term financing plan, the financing costs on the $3,400,000 will be 9 percent, and with a long-term financing plan, the financing costs on the $3,400,000 will be 11 percent. a. Compute the anticipated return after financing costs with the most aggressive asset-financing mix. Anticipated return b. Compute the anticipated return after financing costs with the most conservative asset-financing mix. Anticipated return c. Compute the anticipated return after financing costs with the two moderate approaches to the asset-financing mix.
Suppose you are estimating the WACC for Columbus Inc. It has the following data from its balance sheet: total debt = $200 million; total equity=$120 million. It has 20 million shares outstanding, and its stock is trading at $32 per share. Your analysis shows that the company's current borrowing rate is 7%, and that the cost of equity is 13%. If the company marginal tax rate is 30%, what is its WACC?
You have the following data for your company. Market Value of Equity: $520 Book Value of Debt: $130 Required rate of return on equity: 12% Required rate of return on debt (pre-tax): 7% Corporate tax rate: 25% The company's debt is assumed to be is reasonably safe, so the book value of debt is a reasonably approximation for the market value of debt. What is the weighted average cost of capital for this company?

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Balance Sheets

Total Assets	$5,000,000
Debt	$0
Common stock (=equity)	$5,000,000
Total liabilities & equity	$5,000,000

Income Statements
EBIT	$1,000,000
Interest expense	$0
Taxable Income	$1,000,000
Taxes (40%)	400,000
Net Income (=profit)	600,000
Total dollar return to investors	$600,000
ROE	12.0%