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105. Equity Inc., is currently an all-equity firm. It has 10,000 shares outstanding that sell for
$20 each. The firm has an operating income of $30,000 and pays no taxes. The firm contemplates
a restructuring that would issue $50,000 in 8% debt which will be used to repurchase stock. Show
the value of the firm, EPS, and rate of return on the stock before and after the proposed
restructuring. What changed?
106. Equity Inc., is currently an all-equity firm. It has 10,000 shares outstanding that sell for
$20 each. The firm has an operating income of $30,000 and pays no taxes. The firm contemplates
a restructuring that would issue $50,000 in 8% debt which will be used to repurchase stock.
Assuming that individuals have the same borrowing opportunities as corporations, explain how an
investor can undo the leverage that is proposed by Equity Inc., Under these conditions, what is
the value of restructuring to a firm?
107. Show how leverage increases financial risk by calculating the EPS and return on shares
for a firm with $1 million in 10% debt. The firm also has 50,000 shares outstanding that sell for
$40 each. Three states of the economy are possible: a slump under which the firm would have
operating income of $150,000, a normal state under which the firm will earn $420,000, and a
boom under which the firm will earn $600,000. The firm pays no taxes.
108. Determine the expected return on equity for a firm with a WACC of 12%, $500,000 in 9%
debt, and $800,000 in equity. Both debt and equity are shown at market values, and the firm pays
no taxes. How can the expected return on equity be reduced?
109. Assume a firm maintains debt at a permanent $2.3 million level at an interest rate of 7%.
The corporate tax rate is 35% and there is no chance of financial distress. What would be the
unlevered value of this firm if the levered value is $2.28 million?
110. Calculate the WACC for a firm with a debt-equity ratio of 1.5. The debt pays 10% interest
and the equity is expected to return 16%. Assume a 35% tax rate and risk-free debt.
111. Discuss the trade-off theory of capital structure, including the determination of an
optimal debt level.
112. Discuss how agency problems can develop between shareholders and bondholders when
the firm is experiencing financial distress.
113. Explain the pecking-order theory of capital structure. How might this affect the optimal
capital structure for a firm?
114. What happens when firms cannot pay their creditors?
115. What is the goal of the capital structure decision? What is the financial manager trying to
achieve with this goal?
116. Identify the assumptions underlying the MM proposition that a firm's value is unaffected
by the firm's capital structure.
117. If interest tax shields are valuable, why don't all tax-paying firms borrow as much as
possible?
118. Is financial slack always valuable?
119. Is there a rule for finding optimal capital structure?
120. How do corporate income taxes modify MM's leverage irrelevance proposition?
