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Use the following information to value a firm's assets. Assume the following: the market value of the firm's assets is expected to remain constant over
Use the following information to value a firm's assets. Assume the following: the market value of the firm's assets is expected to remain constant over time so the firm doesn't grow and can be valued as a level perpetuity, the firm has a constant debt-to-assets ratio, the bonds are priced at par, and the stock's expected capital returns are zero. Relevant data: The number of shares on issue is 1 million and the number of bonds is 500,000 The constant annual dividend per share is $4 The bonds have an annual fixed coupon payment of $5 10-year government bonds have a yield of 2.5% and the market risk premium is 6% The beta of levered equity is 0.7 The beta of the bonds is 1.2 Which of the following is the market value of the levered firm's assets? O a $54.8 million O b. $92.1 million O c. $85.5 million O d. $100.6 million O e. $69.2 million Which statement about capital structure is the most correct? O a. Lenders rank ahead of shareholders when the company goes bankrupt. This increased risk for shareholders means the cost of equity is lower than the cost of debt. O b. A company in a risky industry with volatile cash flows will usually choose to take less debt than a company in a stable industry. O c. The more the company borrows, the higher will be its tax shields, therefore a company will always prefer to issue debt than equity. Od. The more the company borrows, the lower will be the after-tax WACC. This increases the present value of the firm free cash flows which represents the value of the levered firm. Therefore, a firm should always seek to borrow as much debt as possible. O e. Because the cost of debt is cheaper than the cost of equity, a company should use as much debt as possible to finance their projects
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