Question

In: Finance

Hardmon Enterprises is currently an​ all-equity firm with an expected return of 12 %12%. It is...

Hardmon Enterprises is currently an​ all-equity firm with an expected return of

12 %12%.

It is considering a leveraged recapitalization in which it would borrow and repurchase existing shares. Assume perfect capital markets.

a. Suppose Hardmon borrows to the point that its​ debt-equity ratio is 0.50. With this amount of​ debt, the debt cost of capital is

4 %4%.

What will the expected return of equity be after this​ transaction?

b. Suppose instead Hardmon borrows to the point that its​ debt-equity ratio is 1.50. With this amount of​ debt, Hardmon's debt will be much riskier. As a​ result, the debt cost of capital will be

6 %6%.

What will the expected return of equity be in this​ case?

c. A senior manager argues that it is in the best interest of the shareholders to choose the capital structure that leads to the highest expected return for the stock. How would you respond to this​ argument?

Solutions

Expert Solution

I have answered the question below

Please up vote for the same and thanks!!!

Do reach out in the comments for any queries

Answer:

HARDMON ENTERPRISES
a) Expected Return 12%
Debt to Equity Ratio 0.5
Debt Cost of Capital 4%
Formula
Expected Return on Equityof Leavered Firm=Expected retun on unleaverd firm+Debt/Equity(Expected return on Unleavered Capital-Cost of debt)
12%+.5(.12-.04) 0.16
Expected retrun on Equity of Leavered firm= 16% %
b) Expected Return 12%
Debt Equity Ratio= 1.5
Debt Cost of Capital= 6%
Formula
Expected Return on Equityof Leavered Firm=Expected retun on unleaverd firm+Debt/Equity(Expected return on Unleavered Capital-Cost of debt)
12%+1.5(.12-.06) 0.21
Expected retrun on Equity of Leavered firm= 21 %
c) Yes it is the best interest of shareholder's to choose the
capital structure that leads to higher expected return
on stock.Generally risk and return are worked in the
same direction.Higher the risk,higher the return.Higher
risk are compensted by higher return.

Related Solutions

5. Hardmon Enterprises is currently an​ all-equity firm with an expected return of 17.2% It is...
5. Hardmon Enterprises is currently an​ all-equity firm with an expected return of 17.2% It is considering borrowing money to buy back some of its existing shares. Assume perfect capital markets. a.Suppose Hardmon borrows to the point that its​ debt-equity ratio is 0.50. With this amount of​ debt, the debt cost of capital is 6%. What will be the expected return of equity after this​ transaction? b. Suppose instead Hardmon borrows to the point that its​ debt-equity ratio is 1.50....
Edison is currently an all-equity firm with an expected return of 12%. Edison's firm value is...
Edison is currently an all-equity firm with an expected return of 12%. Edison's firm value is $500m. It is considering a leveraged recapitalization in which it would borrow and repurchase existing shares. Assume that there are no coporate taxes, no market frictions and no bankruptcy costs. Make sure to read all questions below (4 questions each worth 15 points) Q1 (15 points) Suppose Edison wants to borrow to the point that its debt-equity ratio is 0.50. What is the value...
GRK Co. is currently an all-equity firm with an expected return of 10%. The expected EBIT...
GRK Co. is currently an all-equity firm with an expected return of 10%. The expected EBIT is $ 50,000 forever. Assume that the firm distributes all the net income to the equity holders. The firm is considering a leveraged recapitalization in which it would borrow $ 250,000 and repurchase existing shares. The firm's tax rate is 40%. The cost of debt is 7%. 1/ Calculate the value of the firm with leverage. 2/ Calculate the expected return of equity after...
Determine the expected return on equity for a firm with a WACC of 12%, $500,000 in...
Determine the expected return on equity for a firm with a WACC of 12%, $500,000 in 9% debt, and $800,000 in equity. Both debt and equity are shown at market values, and the firm pays no taxes. How can the expected return on equity be reduced?
Watson, Inc., is an all-equity firm. The cost of the company’s equity is currently 12 percent,...
Watson, Inc., is an all-equity firm. The cost of the company’s equity is currently 12 percent, and the risk-free rate is 4.8 percent. The company is currently considering a project that will cost $11.79 million and last six years. The company uses straight-line depreciation. The project will generate revenues minus expenses each year in the amount of $3.33 million.    If the company has a tax rate of 35 percent, what is the net present value of the project? (Enter...
Watson, Inc., is an all-equity firm. The cost of the company’s equity is currently 12 percent,...
Watson, Inc., is an all-equity firm. The cost of the company’s equity is currently 12 percent, and the risk-free rate is 4.8 percent. The company is currently considering a project that will cost $11.79 million and last six years. The company uses straight-line depreciation. The project will generate revenues minus expenses each year in the amount of $3.33 million.    If the company has a tax rate of 35 percent, what is the net present value of the project? (Enter...
Windsor, Inc. is currently an all-equity financed firm, and its cost of equity is 12%. It...
Windsor, Inc. is currently an all-equity financed firm, and its cost of equity is 12%. It has 20,000 shares outstanding that sell for $25 each. The firm contemplates a restructuring that would borrow $100,000 in perpetual debt at an interest rate of 8% which will be used to repurchase stock. Assume that the corporate tax rate is 35%. (1) Calculate the present value of the interest tax shields and the value of the firm after the proposed restructuring. (2) What...
Rockwood Enterprises is currently an all equity firm and has just announced plans to expand their...
Rockwood Enterprises is currently an all equity firm and has just announced plans to expand their current business. In order to fund this expansion, Rockwood will need toraise $100 million in new capital. After the expansion, Rockwood is expected to produce earnings before interest and taxes of $50 million per year in perpetuity. Rockwood has already announced the planned expansion, but has not yet determined how best to fund the expansion. Rockwood currently has 16 million shares outstanding and following...
Windsor, Inc. is currently an all-equity financed firm, and its cost of equity is 12%.  It has...
Windsor, Inc. is currently an all-equity financed firm, and its cost of equity is 12%.  It has 20,000 shares outstanding that sell for $25 each. The firm contemplates a restructuring that would borrow $100,000 in perpetual debt at an interest rate of 8% which will be used to repurchase stock. Assume that the corporate tax rate is 35%.   (1) Calculate the present value of the interest tax shields and the value of the firm after the proposed restructuring. (2) What will...
2) An all equity firm is considering the following projects: Project beta Expected Return W 0.75...
2) An all equity firm is considering the following projects: Project beta Expected Return W 0.75 10% X 0.9 10.2 Y 1.2 12.0 Z 1.5 15 Assume that the firm has a overall cost of capital of 11%assume that the T Bill is 5%, and the market return is 11 % expected Which projects should be accepted? Which projects will be incorrectly accepted or rejected if the firm used its overall cost of capital as a hurdle rate?
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT