Log in
Finance
2
answers
0
watching
8
views
13 Dec 2019

Financial Risks occurs when the firm decides to use debt in its capital structure. if that is true, then answer the following question below. if, indeed, debt increases the cost of equity, which variable in the following formula that (debt risk) be implied and how is it capture? r_s = r_rf + (r_m - r_rf)beta

Watch
2
answers
0
watching
8
views

For unlimited access to Homework Help, a Homework+ subscription is required.

Unlock all answers

Get 1 free homework help answer.
Get unlimited access
Already have an account? Log in
Share
Patrina Schowalter
Patrina SchowalterLv2
16 Dec 2019
Get unlimited access
Already have an account? Log in
Share

Related questions

1.Fixed cost sources of financing include both debt and common stock.

True

False

2.The desire to maintain high bond ratings will tend to increase the use of debt financing in a firm’s capital structure.

True

False

3. Financial risk is the basic risk inherent in the operations of a firm. It can be viewed as the volatility of a firm’s EBIT.

True

False

4. As a firm increases its use of debt financing, what is the impact upon the cost of equity?

The cost of equity decreases.

The cost of equity remains the same.

The cost of equity increases.

None of the above.

5.An investment banking firm has estimated the following after-tax cost of debt and cost of equity for Marquez Luxury Travel Tours.

Proportion of Debt After-tax Cost of Debt Cost of Equity

30% 3.5% 10.5%

40% 3.8% 11.3%

50% 5.0% 12.9%

60% 7.2% 14.5%

What is the cost of capital at Marquez’ optimal capital structure given the above information?

8.95%

8.40%

8.30%

8.15%

6. How does high business risk affect firm risk?

Higher business risk increases the volatility of capital structure.

Higher business risk increases the volatility of EBIT.

Higher business risk increases the volatility of financial costs.

Higher business risk increases the volatility of the firm’s asset structure.

Which of the following statements is most correct?

If a firm is exposed to a high degree of business risk as a result of its high operating leverage, then it probably should offset this risk by using a larger-than-average amount of financial leverage. This follows because debt has a lower after-tax cost than equity.

Financial risk can be reduced by replacing common equity with preferred stock.

The Hamada equation specifies the effect of financial leverage on beta. It shows how increases in the debt/equity ratio lowers beta.

In the textbook, it was stated that the capital structure that minimizes the WACC also maximizes the firm’s stock price and its total value, but generally not its expected EPS. One reason given for why debt is beneficial is that it shelters operating income from taxes, while it was stated that a disadvantage of excessive debt has to do with costs associated with bankruptcy and financial distress generally.

All of the above statements are false.

Robotics Inc. has a current capital structure of 30% debt and 70% equity. Its current before tax cost of debt is 10%, and its tax rate is 35%. It currently has a levered beta of 1.10. the risk free are is 2.5% and the risk premium on the market is 8%. U.s. Robotics Inc. is considering changing its capital structue to 60% debt and 40% equity. Inceasing the firms level of debt will cause its before tax cost of debt to increase to 12%.

1.What is Robotics unlevered beta?

2. Reiever U.S. Robotics beta using the firm's new captial structure.

3. Use Robotics levered beta under the new capital structure to solve for its cost of equity under the new capital struature.

4. What will the firms WACC be if it makes the changes in the capital structure?

Weekly leaderboard

Home
Homework Help 3,900,000
Finance 370,000
Start filling in the gaps now
Log in