Question 1: The A. J. Croft Company (AJC) currently has $200,000 market value (and book value) of perpetual debt outstanding carrying a coupon rate of 6 percent. Its earnings before interest and taxes (EBIT) are $100,000, and it is a zero-growth company. AJC's current cost of equity is 8.8 percent, and its tax rate is 40 percent. The firm has 10,000 shares of common stock outstanding selling at a price per share of $60.00.
Now assume that AJC is considering changing from its original capital structure to a new capital structure with 50 percent debt and 50 percent equity. If it makes this change, its resulting market value would be $820,000. What would be its new stock price per share?
Question 2: Your firm has debt worth $200,000, with a yield of 9 percent, and equity worth $300,000. It is growing at a 5 percent rate, and faces a 40 percent tax rate. A similar firm with no debt has a cost of equity of 12 percent. Under the MM extension with growth, what is its cost of equity?
Question 3: Which of the following statements is most correct?
a. One advantage of forward contracts is that they are default free.
b. Futures contracts generally trade on an organized exchange and are marked to market daily.
c. Goods are never delivered under forward contracts, but are almost always delivered under futures contracts.
d. Answers a and c are correct.
e. None of the answers above is correct
Question 4: Company A can issue floating rate debt at LIBOR + 1 percent and can issue fixed rate debt at 9 percent. Company B can issue floating rate debt at LIBOR + 1.4 percent and can issue fixed rate debt at 9.4 percent. Suppose A issues floating rate debt and B issues fixed rate debt. They engage in the following swap: A will make a fixed 7.95 percent payment to B, and B will make a floating rate payment equal to LIBOR to A. What are the resulting net payments of A and B?
a. A pays a fixed rate of 9 percent, B pays LIBOR + 1.5 percent.
b. A pays a fixed rate of 8.95 percent, B pays LIBOR + 1.45 percent.
c. A pays LIBOR plus 1 percent, B pays a fixed rate of 9.4 percent.
d. A pays a fixed rate of 7.95 percent, B pays LIBOR.
e. None of the answers above is correct.