05-12-2008, 03:54 AM
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Junior Member
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Join Date: May 2008
Location: US
Posts: 1
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Business finance hw help!
2. Lowell Inc. wishes to increase debt in its capital structure from 30% to 60%. Its current beta is 1.0. The risk-free rate is 6 percent, the market risk premium (Km-Krf) is 6 percent, and the tax rate is 40%. What is the difference between Lowell Inc.’s old and new cost of equity (Ks)?
Ks with old capital structure: 6+6(1)=12
Unlevered beta: 1/[1+(1-0.4)(0.3/0.6)]=0.77
New levered beta: 0.77*[1+(1-0.4)(0.3/0.6)]=1.001
Ks with new capital structure: 6+6(1.001)=12.006
12.006-12=0.006
Did I do this right? I think the 0.3/0.6 is wrong because it needs to be the dept/equity ratio not dept/dept. I do not know how to get this ratio with only this info given. Can anyone help me?
Also:
- You are analyzing two companies for potential investments. Both firms have same sales and operating profits. Firm A has 50 percent variable costs and 50 percent fixed costs, but Firm B has 100 percent variable cost. Which of the following statement is true?
- The percentage decline in Firm A’s operating profit will be less than the percentage decline in Firm B’s operating profit if sales of both firms decline by 10 percent.
- The percentage increase in Firm B’s operating profit will be higher than the percentage increase in Firm A’s operating profit if sales of both firms rise by 10 percent.
- The percentage change in Firm A’s operating profit will be the same as the percentage change in sales.
- The percentage change in Firm B’s operating profit will be the same as the percentage change in sales.
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