When analysts use the term "capital structure," what are they referring to?
2. Why does capital structure affect the market value of a firm?
3. Define "total risk" as it is used in capital structure theory. How is total risk measured?
4. The forecast for your firm indicates there's a 20% chance that Net Income will be $20,000, a 60% chance it will be $30,000, and a 20% chance it will be $40,000.
a. Given these conditions, what is the expected Net Income for your firm next year?
b. Given these conditions and your answer to part a, what is the standard deviation of the Net Income estimate?
c. Given your answers to parts a & b, what is the coefficient of variation (CV) of the net income estimate?
5. What's the difference between business risk and financial risk?
6. Assume your firm is zero-growth and pays all its net income in dividends each year Also assume your firm can borrow money when it needs to at an interest rate of 6%. Currently your firm's cost of equity (Rs) is 9%, but if any money is borrowed that cost will rise to 10%. Sales this year are expected to be $600,000 and operating costs are expected to be $500,000. Your firm's effective tax rate is 40%. Given these conditions, what is the current value of your firm? What will be the new value of your firm if it takes on $200,000 in debt?
End of assignment questions
(see answers to numerical problems below)
Answers to numerical problems:
Question 4a: $30,000
Question 4b: $6,325
Question 4c: 21%
Question 6: $728,000