1.

River Cruises is all-equity-financed.

Current Data | |||||||||

Number of shares | 100,000 | ||||||||

Price per share | $ | 10 | |||||||

Market value of shares | $ | 1,000,000 | |||||||

State of the Economy | |||||||||

Slump | Normal | Boom | |||||||

Profits before interest | $ | 78,250 | 131,500 | 193,000 | |||||

Suppose it now issues $250,000 of debt at an interest rate of 10% and uses the proceeds to repurchase 25,000 shares. Assume that the firm pays no taxes and that debt finance has no impact on firm value. Refer to the above table to compute the missing data. |

Outcomes | |||

Number of shares | |||

Price per share | $10 | ||

Market value of shares | $ | ||

Market value of debt | $ | ||

State of the Economy | |||

Slump | Normal | Boom | |

Profits before interest | $78,250 | $131,500 | $193,000 |

Interest | $ | $ | $ |

Equity earnings | $ | $ | $ |

Earnings per share | $ | $ | $ |

Return on shares | % | % | % |

Expected Outcome |

2.

River Cruises is all-equity-financed with 100,000 shares. It now proposes to issue $300,000 of debt at an interest rate of 12% and use the proceeds to repurchase 30,000 shares at $10 per share. Profits before interest are expected to be $130,000.

a. |
What is the ratio of price to expected earnings for River Cruises before it borrows the $300,000? |

Price-earnings ratio |

b. |
What is the ratio after it borrows? |

Price-earnings ratio |

3.

The common stock and debt of Northern Sludge are valued at $72 million and $28 million, respectively. Investors currently require a return of 16.4% on the common stock and 7.3% on the debt. If Northern Sludge issues an additional $12 million of common stock and uses this money to retire debt, what happens to the expected return on the stock? Assume that the change in capital structure does not affect the risk of the debt and that there are no taxes. **(Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)**

New return on equity | % |

4.

Here is Establishment Industries’ market-value balance sheet (Figures in millions):

Net working capital | $ | 840 | Debt | $ | 700 |

Long-term assets | 2,760 | Equity | 2,900 | ||

Value of firm | $ | 3,600 | $ | 3,600 | |

The debt is yielding 5.0%, and the cost of equity is 16.0%. The tax rate is 37%. Investors expect this level of debt to be permanent. |

a. |
What is Establishment’s WACC? |

WACC | % |

b. |
How would the market-value balance sheet change if Establishment retired all its debt? |

New Market-Value Balance Sheet (figures in millions) |
|||

Net working capital | $ | Debt | $ |

Long-term assets | Equity | ||

Value of firm | $ | Total | $ |

Subject | Mathematics |

Due By (Pacific Time) | 12/05/2015 12:00 pm |

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