Question1. Cavalier Corp's articles of incorporation authorize the firm to issue 500,000 shares of $5 par value common stock, of which 325,000 shares have been issued. Those shares were sold at an average 12% over par. In the quarter that ended last week, Cavalier earned $260,000 net income; 4 percent of that income was paid as a dividend. Prior to the close of the books, Cavalier has $3,545,000 in retained earnings. The company owns no treasury stock.
(a) Calculate the book value of equity.
(b) Now the company sells 25,000 newly issued shares at a price of $4 per share. Par value of the shares is $5. What will be the book value of equity after the issue?
Question2. We want to find out the cost of equity for Firm A. We know that Firm A’s target debt-to-equity ratio is 1.50. We as well know that there is a comparable firm which has exactly same lines of business and hence is anticipated to have the same level of business risk as Firm A. The equity beta of the comparable firm is known to be 1.80. The market value of equity and the market value of debt of the comparable firm are $400 million and $200 million, correspondingly. The corporate tax rate is 20%. Based on the information given, answer given questions.
(a) What would be your estimate of equity beta for Firm A?
(b) If you find that equity beta is different between Firm A and its comparable firm in (a), how would you explain the difference? If you expect no difference explain why they are not different.