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Exam 15: Capital Structure Decisions

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Question 51

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Larsen Films' is analyzing its cost structure. Its fixed operating costs are $470,000, its variable costs of $2.80 per unit produced, and its products sell for $4.00 per unit. What is the company's breakeven point, i.e., at what unit sales volume would income equal costs?

A) 391,667
B) 411,250
C) 431,813
D) 453,403
E) 476,073

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Question 52

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Firm A has a higher degree of business risk than Firm B. Firm A can offset this by using less financial leverage. Therefore, the variability of both firms' expected EBITs could actually be identical.

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Question 53

Multiple Choice

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Which of the following statements is CORRECT?

Other things held constant, an increase in financial leverage will increase a firm's market (or systematic) risk as measured by its beta coefficient.

Best Bagels, Inc. (BB) Best Bagels, Inc. (BB) currently has zero debt. Its earnings before interest and taxes (EBIT) are $100,000, and it is a zero growth company. BB's current cost of equity is 13%, and its tax rate is 40%. The firm has 20,000 shares of common stock outstanding selling at a price per share of $23.08. -Refer to the data for Best Bagels, Inc. (BB) . BB is considering moving to a capital structure that is comprised of 20% debt and 80% equity, based on market values. The debt would have an interest rate of 7%. The new funds would be used to repurchase stock. It is estimated that the increase in risk resulting from the additional leverage would cause the required rate of return on equity to rise to 14%. If this plan were carried out, what would BB's new value of operations be?

Wilson Dover Inc. The total value (debt plus equity) of Wilson Dover Inc. is $500 million and the face value of its 1-year coupon debt is $200 million. The volatility (σ) of Wilson Dover's total value is 0.60, and the risk-free rate is 5%. Assume that N(d₁) = 0.9720 and N(d₂) = 0.9050. ​ -Refer to the data for Wilson Dover Inc. What is the value (in millions) of Wilson Dover's equity if it is viewed as an option?

The MM model is the same as the Miller model, but with zero corporate taxes.