Question

In: Finance

Air Tampa has just been incorporated, and its board of directors is grappling with the question...

Air Tampa has just been incorporated, and its board of directors is grappling with the question of optimal capital structure. The company plans to offer commuter air services between Tampa and smaller surrounding cities. Jaxair has been around for a few years, and it has about the same basic business risk as Air Tampa would have. Jaxair's market-determined beta is 2, and it has a current market value debt ratio (total debt to total assets) of 45% and a federal-plus-state tax rate of 35%. Air Tampa expects to be only marginally profitable at start-up; hence its tax rate would only be 20%. Air Tampa's owners expect that the total book and market value of the firm's stock, if it uses zero debt, would be $14 million. Air Tampa's CFO believes that the MM and Hamada formulas for the value of a levered firm and the levered firm's cost of capital should be used because zero growth is expected. (These are given in equations VL = VU + VTax shield = VU + TD, rsL = rsU + (rsU - rd)(1 - T)(D/S), and b = bU[1 + (1 - T)(D/S)].) Estimate the beta of an unlevered firm in the commuter airline business based on Jaxair's market-determined beta. (Hint: This is a levered beta; use Equation b = bU[1 + (1 - T)(D/S)] and solve for bU.) Do not round intermediate calculations. Round your answer to three decimal places. Now assume that rd = rRF = 8% and that the market risk premium RPM = 6%. Find the required rate of return on equity for an unlevered commuter airline. Do not round intermediate calculations. Round your answer to three decimal places. % Air Tampa is considering three capital structures: (1) $3 million debt, (2) $6 million debt, and (3) $9 million debt. Estimate Air Tampa's rs for these debt levels. Do not round intermediate calculations. Round your answers to two decimal places. Air Tampa's rs for $3 million debt: % Air Tampa's rs for $6 million debt: % Air Tampa's rs for $9 million debt: % Calculate Air Tampa's rs at $9 million debt while assuming its federal-plus-state tax rate is now 40%. (Hint: The increase in the tax rate causes VU to drop to $10.5 million.) Do not round intermediate calculations. Round your answer to two decimal places. % Compare this with your corresponding answer to part c. Higher tax rate the financial risk premium at a given market value debt/equity ratio.

Solutions

Expert Solution


Related Solutions

Air Tampa has just been incorporated, and its board of directors is grappling with the question...
Air Tampa has just been incorporated, and its board of directors is grappling with the question of optimal capital structure. The company plans to offer commuter air services between Tampa and smaller surrounding cities. Jaxair has been around for a few years, and it has about the same basic business risk as Air Tampa would have. Jaxair's market-determined beta is 1.4, and it has a current market value debt ratio (total debt to total assets) of 50% and a federal-plus-state...
Air Tampa has just been incorporated, and its board of directors is grappling with the question...
Air Tampa has just been incorporated, and its board of directors is grappling with the question of optimal capital structure. The company plans to offer commuter air services between Tampa and smaller surrounding cities. Jaxair has been around for a few years, and it has about the same basic business risk as Air Tampa would have. Jaxair's market-determined beta is 1.5, and it has a current market value debt ratio (total debt to total assets) of 60% and a federal-plus-state...
Air Tampa has just been incorporated, and its board of directors is grappling with the question...
Air Tampa has just been incorporated, and its board of directors is grappling with the question of optimal capital structure. The company plans to offer commuter air services between Tampa and smaller surrounding cities. Jaxair has been around for a few years, and it has about the same basic business risk as Air Tampa would have. Jaxair's market-determined beta is 1.8, and it has a current market value debt ratio (total debt to total assets) of 55% and a federal-plus-state...
Air Tampa has just been incorporated, and its board of directors is grappling with the question...
Air Tampa has just been incorporated, and its board of directors is grappling with the question of optimal capital structure. The company plans to offer commuter air services between Tampa and smaller surrounding cities. Jaxair has been around for a few years, and it has about the same basic business risk as Air Tampa would have. Jaxair's market-determined beta is 1.8, and it has a current market value debt ratio (total debt to total assets) of 60% and a federal-plus-state...
Air Tampa has just been incorporated, and its board of directors is grappling with the question...
Air Tampa has just been incorporated, and its board of directors is grappling with the question of optimal capital structure. The company plans to offer commuter air services between Tampa and smaller surrounding cities. Jaxair has been around for a few years, and it has about the same basic business risk as Air Tampa would have. Jaxair's market-determined beta is 1.4, and it has a current market value debt ratio (total debt to total assets) of 40% and a federal-plus-state...
Air Tampa has just been incorporated, and its board of directors is grappling with the question...
Air Tampa has just been incorporated, and its board of directors is grappling with the question of optimal capital structure. The company plans to offer commuter air services between Tampa and smaller surrounding cities. Jaxair has been around for a few years, and it has about the same basic business risk as Air Tampa would have. Jaxair's market-determined beta is 1.9, and it has a current market value debt ratio (total debt to total assets) of 45% and a federal-plus-state...
Air Tampa has just been incorporated, and its board of directors is grappling with the question...
Air Tampa has just been incorporated, and its board of directors is grappling with the question of optimal capital structure. The company plans to offer commuter air services between Tampa and smaller surrounding cities. Jaxair has been around for a few years, and it has about the same basic business risk as Air Tampa would have. Jaxair's market-determined beta is 1.7, and it has a current market value debt ratio (total debt to total assets) of 40% and a federal-plus-state...
Air Tampa has just been incorporated, and its board of directors is grappling with the question...
Air Tampa has just been incorporated, and its board of directors is grappling with the question of optimal capital structure. The company plans to offer commuter air services between Tampa and smaller surrounding cities. Jaxair has been around for a few years, and it has about the same basic business risk as Air Tampa would have. Jaxair's market-determined beta is 1.8, and it has a current market value debt ratio (total debt to total assets) of 40% and a federal-plus-state...
Problem 21-04 Business and Financial Risk—MM Model Air Tampa has just been incorporated, and its board...
Problem 21-04 Business and Financial Risk—MM Model Air Tampa has just been incorporated, and its board of directors is grappling with the question of optimal capital structure. The company plans to offer commuter air services between Tampa and smaller surrounding cities. Jaxair has been around for a few years, and it has about the same basic business risk as Air Tampa would have. Jaxair's market-determined beta is 1.8, and it has a current market value debt ratio (total debt to...
Apple Incorporated (AI) board of directors has indicated that they will repurchase AI’s stock effective July...
Apple Incorporated (AI) board of directors has indicated that they will repurchase AI’s stock effective July 1st, 2020. You currently hold 100 AI’s stock. Explain in detail, the concept of “information content” to be derived from the board of director’s pronouncement. Discuss the likely impact of this pronouncement on AI’s stock price? In respect of this announcement, discuss the concept of the “signaling theory” and how will managers of AI be placed in an advantageous position ahead of the normal...
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT