9. Hardmon Enterprises is currently an all-equity firm with an expected return of 17.9%. It is considering borrowing money to buy back some of its existing shares. Assume perfect capital markets. a. Suppose Hardmon borrows to the point that its debt-equity ratio is 0.50. With this amount of debt, the debt cost of capital is 4%. What will be the expected return of equity after this transaction? b. Suppose instead Hardmon borrows to the point that its debt-equity ratio is 1.50. With this amount of debt, Hardmon's debt will be much riskier. As a result, the debt cost of capital will be 6%. What will be the expected return of equity in this case? C. A senior manager argues that it is in the best interest of the shareholders to choose the capital structure that leads to the highest expected return for the stock. How would you respond to this argument? a. Suppose Hardmon borrows to the point that its debt-equity ratio is 0.50. With this amount of debt, the debt cost of capital is 4%. What will be the expected return of equity after this transaction? The expected return is %. (Round to two decimal places.) b. Suppose instead Hardmon borrows to the point that its debt-equity ratio is 1.50. With this amount of debt, Hardmon's debt will be much riskier. As a result, the debt cost of capital will be 6%. What will be the expected return of equity in this case? The expected return is %. (Round to two decimal places.) C. A senior manager argues that it is in the best interest of the shareholders best choice below.) choose the capital structure that leads to the highest expected return for the stock. How would you respond to this argument? (Select the O A. True, because this will result in a higher market value for the stock. OB. True, because the manager's argument is correct. O C. True, because this would also lead to the highest eamings per share. OD. False, because returns are higher because risk is higher and the return fairly compensates for the risk. 10. Suppose Microsoft has no debt and a WACC of 9.2%. If the average debt-to-value ratio for the software industry is 12%, what would its cost of equity be if it took on the average amount of debt for its industry at a cost of debt of 5%? The cost of equity is %. (Round to two decimal places.) 11. Assume that Microsoft has a total market value of $297 billion and a marginal tax rate of 35%. If it permanently changes its leverage from no debt by taking on new debt in the amount of 12.7% of its current market value, what is the present value of the tax shield it will create? The present value of the tax shield is $ billion. (Round to two decimal places.)
