AQ&Q has EBIT of $2 million, total assets of $10 million, stock holder s equity of $4 million, and pretax interest expense of 10 percent.
a) What is AQ&Q s indifference level of EBIT?
b) Given its current situation, might it benefit from increasing or decreasing its use of debt? Explain.
c) Suppose we are to AQ&Q s average tax rate is 40 percent. How does this affect your answers to (A) and (B)?
4) Faulkner s Fine Fries, Inc. (FFF) is thinking about reducing its debt burden. Given the following capital structure information and an expected EBIT of $50 million (plus or minus 10 percent) next year, should FFF change their capital structure?
CURRENT PROPOSED
Total assets $750 million $750 million
Debt $450 million $300 million
Equity $300 million $450 million
Common stock price $30 $30
Number of shares 10,000,000 15,000,000
Interest rate 12% 12%
8) The Nutrex Corporation wants to calculate its weighted average cost of capital. Its target capital structure weights are 40 percent long-term debt and 60 percent common equity. The before-tax cost of debt is estimated to be 10 percent and the company is in the 40 percent tax bracket. The current risk-free interest rate is 8 percent on Treasury bills. The expected return on the market is 13 percent and the firm s stock beta is 1.8.
a. What is Nutrex s cost of debt?
b. Estimate Nutrex s expected return on common equity using the security market line.
c. Calculate the after-tax weight average cost of capital.