Question

In: Finance

First on the president’s list is an evaluation of where the firm is at the present....

First on the president’s list is an evaluation of where the firm is at the present. He has provided you with all the information you need to find the answers he wants. For starters, the capital structure for the past year of operations is:

Mortgage bonds (Debt) $2,000

Debentures (Debt) 1,500

Retained earnings (Equity) 500

What is the current financial mix (this was in the Cost of Capital video lecture)?

Answer:

The president informed you that DWOTT has chosen to raise capital by issuing stocks and bonds in the ratio of 6.5:3.5.

What does that mean for your company (in other words, their target is no more than 35% debt…how does that relate to where they currently are? Can they afford to take on more debt)?

Expert Solution

Q. 1). Solution :- Current financial mix (of debt and equity):-

Value of debt = Amount of bonds + Amount of debentures.

= 2000 + 1500

= $ 3500.

Value of equity = $ 500. (Retained earnings)

Weight of debt = Value of debt / (Value of debt + Value of equity)

= 3500 / (3500 + 500)

= 3500 / 4000

= 0.875

Weight of equity = Value of equity / (Value of debt + Value of equity)

= 500 / (3500 + 500)

= 500 / 4000

= 0.125

Current financial mix = Debt : Equity

= 0.875 : 0.125 (i.e., 87.5 % capital raised by issuing bonds / debentures and remaining 12.5 % capital raised by issuing stocks).

Conclusion :- Current financial mix of debt and equity = 0.875 : 0.125 (87.50 % in debt and 12.50 % in equity).

Q. 2). Answer:- If company choosing to raise capital up to maximum 35 % only by issuing bonds / debentures (i.e., debt) then it may be due to cost of debt is higher than the cost of equity and accordingly, company is choosing an ideal combination of debt and equity that may attain the marginal goal i.e., maximizing of market value will be maximized or the cost of capital (weighted average cost of capital) will be minimized when the real cost of each source of funds is the same. It is formidable task of the finance manager to determine the combination of various sources of finance (debt / equity).

The company can afford to have more debt amount in its capital structure provided that the cost of debt does not exceed than the cost of equity, in other words, Capital structure should combine various sources of finance into an optimum capital mix, involving the least average cost of capital and in this way helping in maximizing of returns for company in long-run.

jeff jeffy answered 1 year ago

Choose a US firm and a country where the firm is not currently present. Develop an...

Choose a US firm and a country where the firm is not currently present. Develop an in‐ house proposal suggesting whether and how your firm should enter the market. Be sure to include: ‐ Financial analysis of investment decision (NPV of cash flows) ‐ Foreign exchange risk analysis and risk mitigation recommendation ‐ Possible financing alternatives ‐ Tax optimization views

There are two parts to this question first part: Consider a production facility, where the present...

There are two parts to this question first part: Consider a production facility, where the present value of expected future cash inflows from production, V = 80, may fluctuate in line with the random fluctuation in demand (u = 1.4, d = 0.71 per period and the risk-free rate, r = 5%). Suppose management has the option in two years, to contract to half the scale and half the value of the project (c = 50%), and recover $40m (Rc...

list and describe the steps of process evaluation

Explain briefly why major tax acts often occur in the first year of a new president’s...

Explain briefly why major tax acts often occur in the first year of a new president’s term.

list the four basic organic molecule types, and for each, describe where it is first meaningfully...

list the four basic organic molecule types, and for each, describe where it is first meaningfully digested in humans and give the enzyme used to break it down.

11. You are given the information of firm A and B for their performance evaluation. Firm...

11. You are given the information of firm A and B for their performance evaluation. Firm A B Sales 60 55 EAT 20 18 Total Assets 75 72 Stockholder’s Equity 40 40 Suppose the industry average of net profit margin ratio, total asset turnover and equity multiplier is around 30%, 0.78 times and 1.9 respectively. Which firm appears to have problems? Firm A has problems. Firm B has problems. None of them presents problems. Both of them...

The Evaluation is the segment of the grant where the funder can determine if there is...

The Evaluation is the segment of the grant where the funder can determine if there is a sound and comprehensive plan for assessing impact. The evaluation plan should address all of the areas that can or should be impacted by the proposal program/project/research. Please go to the coloradogrants.org website and review the evaluation plans for both the Centerville Community Center Proposal and the London Family Center Proposal. Does one seem stronger then another and as a grant reviewer which would...

List and discuss each of the three strategy evaluation activities

• Present a scenario where the sender is not clear in delivering a message. • Present...

• Present a scenario where the sender is not clear in delivering a message. • Present a scenario where the receiver has decoded a message incorrectly. • Why are rumors detrimental to a company? • Why are rumors especially harmful in the media? What are ways of eliminating and preventing rumors in an organization? • Listening skills are essential to a good manager. Describe a scenario when you felt you were not heard and it affected the communication process. •...

List the performance evaluation measures. When is it appropriate to use them?