The firms HL and LL are identical except for their debt-to-total-assets ratios and interest rates on debt. Each has $20 million in assets, earned $4 million before interest and taxes, and has a 40 percent marginal tax rate. Firm HL, however, has a debt-to-total-assets ratio (D/TA) of 50 percent and pays 12 percent interest on its debt, whereas LL has a 30 percent debt-to-total-assets ratio and pays only 10 percent interest on debt.

Calculate the rate of return on equity (net income/equity) for each firm.

Jackson Trucking Company is in the process of setting its target capital structure. The CFO believes that the optimal debt-to-capital ratio is somewhere between $20 \%$ and $50 \%$, and her staff has compiled the following projections for EPS and the stock price at various debt levels:

$$\begin{array}{ccc} \begin{array}{c} \textbf{ Debt/Capital } \\ \textbf{ Ratio } \end{array} & \begin{array}{c} \textbf{ Projected } \\ \textbf{ EPS } \end{array} & \begin{array}{c} \textbf{ Projected Stock } \\ \textbf{ Price } \end{array} \\ \hline 20 \% & \$ 3.20 & \$ 35.00 \\ 30 & 3.45 & 36.50 \\ 40 & 3.75 & 36.25 \\ 50 & 3.50 & 35.50 \end{array}$$

Assuming that the firm uses only debt and common equity, what is Jackson's optimal capital structure? At what debt-to-capital ratio is the company's WACC minimized?

Given the following information, calculate the expected value for Firm C’s EPS. Data for Firms A and B are as follows: $\mathrm{E}\left(\mathrm{EPS}_{\mathrm{A}}\right)=\$ 5.10, \sigma_{\mathrm{A}}=\$ 3.61, \mathrm{E}\left(\mathrm{EPS}_{\mathrm{B}}\right)=\$ 4.20$, and $\sigma_{\mathrm{B}}=\$ 2.96$.

$$\begin{matrix} \text{ } & \text{Probability}\\ \text{ } & \text{0.1} & \text{0.2} & \text{0.4} & \text{0.2} & \text{0.1}\\ \text{Firm A: }{\mathrm{EPS}_{\mathrm{A}}} & \text{(\$ 1.50)} & \text{\$ 1.80} & \text{\$ 5.10} & \text{\$ 8.40} & \text{\$ 11.70}\\ \text{Firm B: }{\mathrm{EPS}_{\mathrm{B}}} & \text{(1.20)} & \text{1.50} & \text{4.20} & \text{6.90} & \text{9.60}\\ \text{Firm C: }{\mathrm{EPS}_{\mathrm{C}}} & \text{(2.40)} & \text{1.35} & \text{5.10} & \text{8.85} & \text{12.60}\\ \end{matrix}$$

b. You are given that $\sigma_{\mathrm{C}}=\$ 4.11$. Discuss the relative riskiness of the three firms’ earnings.

Given the following information, calculate the expected value for Firm C's EPS. $\text{E}\left(\mathrm{EPS}_{\mathrm{A}}\right)=\$ 5.10$ and $\sigma_{\mathrm{A}}=\$ 3.61 ; \mathrm{E}\left(\mathrm{EPS}_{\mathrm{B}}\right)=\$ 4.20$ and $\sigma_{\mathrm{B}}=\$ 2.96 ;$ and $\sigma_{\mathrm{C}}=\$ 4.11$.

$$\begin{array}{lrrrrr} & 0.1 & 0.2 & 0.4 &{0.2} &{0.1} \\ \hline \text{Firm A: EPS}_A & (\$ 1.50) & \$ 1.80 & \$ 5.10 & \$ 8.40 & \$ 11.70 \\ \text{Firm B: EPS}_B & (1.20) & 1.50 & 4.20 & 6.90 & 9.60 \\ \text{Firm C: EPS}_C & (2.40) & 1.35 & 5.10 & 8.85 & 12.60 \end{array}$$

Marble Construction estimates that its WACC is 10% if equity comes from retained earnings. However, if the company issues new stock to raise new equity, it estimates that its WACC will rise to 10.8%. The company believes that it will exhaust its retained earnings at $2,500,000 of capital due to the number of highly profitable projects available to the firm and its limited earnings. The company is considering the following seven investment projects:$ $$ \begin{matrix} \text{Project} & \text{Size} & \text{IRR}\\ \text{A} & \text{\$ 650.000} & \text{14.0\\%}\\ \text{B} & \text{1.050.000} & \text{13.5}\\ \text{C} & \text{1.000.000} & \text{11.2}\\ \text{D} & \text{1.200.000} & \text{11.0}\\ \text{E} & \text{500.000} & \text{10.7}\\ \text{F} & \text{650.000} & \text{10.3}\\ \text{G} & \text{700.000} & \text{10.2}\\ \end{matrix} $$ $ Assume that each of these projects is independent and that each is just as risky as the firm’s existing assets. Which set of projects should be accepted, and what is the firm’s optimal capital budget?

A company's fixed operating costs are $\$ 500,000$, its variable costs are $\$ 3.00$ per unit, and the product's sales price is $\$ 4.00$. What is the company's break-even point; that is, at what unit sales volume will its income equal its costs?

Terrell Trucking Company is in the process of setting its target capital structure. The CFO believes that the optimal debt-to-capital ratio is somewhere between 20 percent and 50 percent, and her staff has compiled the following projections for EPS and the stock price at various debt levels:

$$\begin{array}{ccc} \begin{array}{c} \text { Debt/Capital } \\ \text { Ratio } \end{array} & \begin{array}{c} \text { Projected } \\ \text { EPS } \end{array} & \begin{array}{c} \text { Projected Stock } \\ \text { Price } \end{array} \\ \hline 20 \text{ percent} & 3.10 \text{ dollars} & 34.25 \text{ dollars} \\ 30 & 3.55 & 36.00 \\ 40 & 3.70 & 35.50 \\ 50 & 3.55 & 34.00 \end{array}$$

Assuming that the firm uses only debt and common equity, what is Terrell’s optimal capital structure? At what debt-to-capital ratio is the company’s WACC minimized?

Given the following information, discuss the relative riskiness of the three firms' (A, B, and C) earnings.

$\text{E}\left(\mathrm{EPS}_{\mathrm{A}}\right)=\$ 5.10$ and $\sigma_{\mathrm{A}}=\$ 3.61 ; \mathrm{E}\left(\mathrm{EPS}_{\mathrm{B}}\right)=\$ 4.20$ and $\sigma_{\mathrm{B}}=\$ 2.96 ;$ and $\sigma_{\mathrm{C}}=\$ 4.11$.

$$\begin{array}{lrrrrr} & 0.1 & 0.2 & 0.4 &{0.2} &{0.1} \\ \hline \text{Firm A: EPS}_A & (\$ 1.50) & \$ 1.80 & \$ 5.10 & \$ 8.40 & \$ 11.70 \\ \text{Firm B: EPS}_B & (1.20) & 1.50 & 4.20 & 6.90 & 9.60 \\ \text{Firm C: EPS}_C & (2.40) & 1.35 & 5.10 & 8.85 & 12.60 \end{array}$$

The Neal Company wants to estimate next year’s return on equity (ROE) under different financial leverage ratios. Neal’s total capital is $14 million, it currently uses only common equity, it has no future plans to use preferred stock in its capital structure, and its federal-plus-state tax rate is 40%. The CFO has estimated next year’s EBIT for three possible states of the world:$4.2 million with a 0.2 probability, $2.8 million with a 0.5 probability, and$700,000 with a 0.3 probability. Calculate Neal’s expected ROE, standard deviation, and coefficient of variation for each of the following debt-to-capital ratios; then evaluate the results: $$ \begin{matrix} \text{Debt/Capital Ratio} & \text{Interest Rate}\\ \text{0\\%} & \text{--}\\ \text{10} & \text{9\\%}\\ \text{50} & \text{11}\\ \text{60} & \text{14}\\ \end{matrix} $$

Banyan Industries has two divisions, a tax rate of 30%, and a minimum rate of return of 20%. Division A has a weighted average cost of capital of 9.5% and is looking at a new project that will generate a profit of $1,200,000 from a machine that costs$4,000,000. Division B has a weighted average cost of capital of 9.5% and is looking at a new project that will generate a profit of $1,350,000 from a machine that costs$5,000,000. D. If Banyan uses RI, which division has the better project and by how much?

Gamma Medical's stock trades at $\$ 90$ a share. The company is contemplating a $3$-for-$2$ stock split. Assuming that the stock split will have no effect on the market value of its equity, what will be the company's stock price following the stock split?

Tartan Industries currently has total capital equal to 4 million dollars, has zero debt, is in the 40 percent federal-plus-state tax bracket, has a net income of 1 million dollars, and distributes 40 percent of its earnings as dividends. Net income is expected to grow at a constant rate of 3 percent per year, 200,000 shares of stock are outstanding, and the current WACC is 12.30 percent.

The company is considering a recapitalization where it will issue 2 million dollars in debt and use the proceeds to repurchase stock. Investment bankers have estimated that if the company goes through with the recapitalization, its before-tax cost of debt will be 10 percent and its cost of equity will rise to 15.5 percent.

a. What is the stock's current price per share (before the recapitalization)?

b. Assuming that the company maintains the same payout ratio, what will be its stock price following the recapitalization? Assume that shares are repurchased at the price calculated in part a.

Banyan Industries has two divisions, a tax rate of 30%, and a minimum rate of return of 20%. Division A has a weighted average cost of capital of 9.5% and is looking at a new project that will generate a profit of $1,200,000 from a machine that costs$4,000,000. Division B has a weighted average cost of capital of 9.5% and is looking at a new project that will generate a profit of $1,350,000 from a machine that costs$5,000,000. B. Calculate the RI for each of Banyan’s division.

The calculation of WACC involves calculating the weighted average of the required rates of return on debt and equity, where the weights equal the percentage of each type of financing in the firm's overall capital structure.

_______Is the symbol that represents the cost of raising capital through retained earnings in the weighted average cost of capital (WACC) equation.

Reymond Co. Has $1.1 million of debt,$1 million of preferred stock, and $2.1 million of common equity. What would be its weight on common equity?