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Tutorial 7 - Capital Structure PDF

Harley Motors has $10 million in assets financed with $2 million of debt and $8 million in equity. Its beta is 1.2 and tax rate is 40%. Using the Hamada equation, the unlevered beta can be found. Bloom Flower has a capital structure of 20% debt, 80% equity. Its cost of equity is 12.5%. Its current levered beta and unlevered beta can be calculated. If it changes its structure to 40% debt, 60% equity, its new levered beta and cost of equity can be determined. Cyclone Software wants to estimate its optimal capital structure. If it changes its structure from 25% debt to 50% debt, its

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151 views

Tutorial 7 - Capital Structure PDF

Harley Motors has $10 million in assets financed with $2 million of debt and $8 million in equity. Its beta is 1.2 and tax rate is 40%. Using the Hamada equation, the unlevered beta can be found. Bloom Flower has a capital structure of 20% debt, 80% equity. Its cost of equity is 12.5%. Its current levered beta and unlevered beta can be calculated. If it changes its structure to 40% debt, 60% equity, its new levered beta and cost of equity can be determined. Cyclone Software wants to estimate its optimal capital structure. If it changes its structure from 25% debt to 50% debt, its

Uploaded by

Cham
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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Tutorial 7 – Capital Structure

1) Harley Motors has $10 million in assets, which were financed with $2million of debt and
$8 million in equity. Harley’s beta is currently 1.2, and its tax rate is 40%. Use the
Hamada equation to find Harley’s unlevered beta.

2) Currently, Bloom Flower Inc. has a capital structure consisting of 20% debt and 80%
equity. The risk-free rate is 5%, and the market risk premium is 6%. Using the CAPM,
Bloom estimates that its cost of equity is currently 12.5%. The company has a 40% tax
rate.
a) What is the current levered beta on Bloom’s common stock?
b) What would be Bloom’s beta if the company had no debt (unlevered) in its capital
structure?

Bloom’s financial staff is considering changing its capital structure to 40% debt and 60%
equity. The proposed change will have no effect on the company’s tax rate.
c) What would be Bloom’s new levered beta?
d) What would be the company’s new cost of equity if it adopted the proposed change in
capital structure?

3) Cyclone Software Co. is trying to estimate its optimal capital structure. Cyclone’s current
capital structure consists of 25% debt and 75% equity; however, management believes
the firm should use more debt. The risk-free rate, is 5%, the market risk premium is 6%,
and the firm’s tax rate is 40%. Currently, Cyclone’s cost of equity is 14%, which is
determined on the basis of the CAPM. What would be Cyclone’s estimated new cost of
equity if it were to change its capital structure from its present capital structure to 50%
debt and 50% equity?

4) HELP International Corporation (HIC) is considering a large – scale recapitalization.


Currently, HIC is financed with 25% debt and 75% equity. HIC is considering increasing
its level of debt until it is financed with 60% debt and 40% equity. The beta on its
common stock at the current level of debt is 1.5, the risk – free rate is 6%, and the market
risk premium is 4% and federal – plus state tax rate is 40%. Calculate the value of HIC’s
current cost of equity, HIC’s unlevered beta, the new beta and new cost of equity if HIC
recapitalizes.

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