Old Fashion Corp. is an all-equity firm famous for its antique furniture business. If the firm uses
Question:
Old Fashion Corp. is an all-equity firm famous for its antique furniture business. If the firm uses \(36 \%\) leverage through issuance of long-term debt, the CFO predicts that there is a \(20 \%\) chance that the \(\mathrm{ROE}(\) Return on Equity) will be \(10 \%, 40 \%\) chance that the ROE will be \(15 \%\), and \(40 \%\) chance that the ROE will be \(20 \%\). The firm is tax-exempt. Explain whether the firm should change its capital structure if the forecast of the CFO changes to \(30 \%, 50 \%\) and \(20 \%\) chances respective for the three ROE possibilities. That is, tell us whether the value of assets and equity change as a result of the changes in ROEs.
Step by Step Answer:
Lectures On Corporate Finance
ISBN: 9789812568991
2nd Edition
Authors: Peter L Bossaerts, Bernt Arne Odegaard