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Chapter 16 - Assessing Long-Term Debt, Equity, and Capital Structure

Week 13 Unit 11

CHAPTER 16 – ASSESSING LONG-TERM DEBT, EQUITY, AND CAPITAL


STRUCTURE

Questions

1. How will passive and active capital structure changes differ?

2. Why is debt often referred to as leverage in finance?

Problems

LG3 16-1 Capital Structure Weights Suppose that Papa Bell, Inc.’s, equity is currently
selling for $55 per share, with 4 million shares outstanding. If the firm also has 17,000
bonds outstanding, which are selling at 94 percent of par, what are the firm’s current
capital structure weights?

16-2 Restructuring Strategy Suppose that Lil John Industries’ equity is currently selling
for $27 per share and that there are 2 million shares outstanding. The firm also has 50,000
bonds outstanding, which are selling at 103 percent of par. If Lil John was considering an
active change to their capital structure so that the firm would have a D/E of 1.4, which type
of security (stocks or bonds) would they need to sell to accomplish this, and how much
would they have to sell?

16-1
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McGraw-Hill Education.
Chapter 16 - Assessing Long-Term Debt, Equity, and Capital Structure

16-3 Standard Deviation in EPS after Leveraging Daddi Mac, Inc., doesn’t face any
taxes and has $350 million in assets, currently financed entirely with equity. Equity is
worth $37 per share, and book value of equity is equal to market value of equity. Also, let’s
assume that the firm’s expected values for EBIT are dependent upon which state of the
economy occurs this year, with the possible values of EBIT and their associated
probabilities shown as follows:

STATE RECESSION AVERAGE BOOM


Probability of state 0.25 0.55 0.20

Expected EBIT in $5 million $10 million $17 million


state

The firm is considering switching to a 20-percent-debt capital structure, and has determined
that they would have to pay an 8 percent yield on perpetual debt regardless of whether they
change their capital structure. What will be the standard deviation in EPS if they switch to
the proposed capital structure?

LG6 16-4 Break-even EBIT with Taxes GTB, Inc., has a 34 percent tax rate and has $100
million in assets, currently financed entirely with equity. Equity is worth $7 per share, and
book value of equity is equal to market value of equity. Also, let’s assume that the firm’s
expected values for EBIT depend upon which state of the economy occurs this year, with
the possible values of EBIT and their associated probabilities shown as follows:

STATE PESSIMISTIC OPTIMISTIC


Probability of state 0.45 0.55

Expected EBIT in state $5 million $19 million

The firm is considering switching to a 40-percent-debt capital structure, and has determined
that they would have to pay a 12 percent yield on perpetual debt in either event. What will
be the break-even level of EBIT?

16-2
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.