Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

QUESTION 4 SHOW ALL WORK FOR FULL CREDIT. You have been asked by Kris International for advice on whether they are using the right mix

image text in transcribed
QUESTION 4 SHOW ALL WORK FOR FULL CREDIT. You have been asked by Kris International for advice on whether they are using the right mix of debt and equity to fund their operations. The firm has 120 million shares trading at $10 a share and $300 million (in market value) in outstanding debt. The current levered beta for the firm is 1.10 and the pre-tax cost of borrowing is 6%. The marginal tax rate is 40%, the risk free rate is 5%, and the market risk premium is 4%. a. Estimate the current cost of capital for the firm. (4 marks) b. If the market is valuing the firm correctly today and the expected free cash flow to the firm next year is $80 million, estimate the implied growth rate in this cash flow in perpetuity (given the cost of capital that you estimated in part a). (7 marks) c. You estimate the optimal debt ratio for the firm to be 40% and believe that the cost of capital will drop to 8%, if you move to the optimal by borrowing money and buying back shares. If you buy back the shares at $10.25/share, estimate the increase in value per share for the remaining shares. (7 marks) d. Cost of debt is always cheaper than cost of equity. Therefore, the optimal debt ratio is all debt. How would you respond? (2 marks)

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Microeconomics

Authors: Glenn Hubbard, Anthony O'Brien

7th Edition

0134737504, 978-0134737508

More Books

Students also viewed these Finance questions

Question

Solve the following 1,4 3 2TT 5x- 1+ (15 x) dx 5X

Answered: 1 week ago

Question

2. In what way can we say that method affects the result we get?

Answered: 1 week ago