Question 3 (5marks) UNIT 4: CAPITAL STRUCTURE THEORY AND POLICY

a) Crown Data(CD) has a current capital structure that consists of $120 million in common equity (15 million shares) and $80 million in long-term debt with an average interest rate of 11%. CD is considering an expansion project that will cost $22 million. The project will be financed either by issuing long-term debt at a cost of 12.5%, or the sale of new common stock at $35 per share. The firm's marginal tax rate is 40%. What is the EBIT indifference point between the two financing options? (2 marks)

b) TCA Cable has fixed operating costs of $2.6 million, and its variable cost ratio is 0.30. TCA has $4.0 million

in bonds outstanding with a coupon interest rate of 12%.

TCA has 1.0 million common shares and 1,000,000 shares of $1.75 preferred stock outstanding.

Total revenues for TCA Cable are $14.2 million. If TCA has a marginal tax rate of 40%, what is its degree of combined leverage? (1 marks)

c) Biotec has estimated the costs of debt and equity capital for various proportions of debt in its

capital structure:

% of Debt Cost of Debt (%) Cost of Equity (%)

35 5.4 13.8

40 5.6 14.0

45 5.9 14.3

50 6.4 14.7

If Biotec pays a current dividend of $1.00 and expects dividends to grow at a constant rate of 7%, what is Biotec's stock price if it obtains its optimal capital structure? (2 marks)