P1. AQ&Q has EBIT of $2 million,
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 told AQ&Q’s average tax rate is 40%. How does this affect your answers to (a) and (b)?
P2. 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%) next year, should FFF change their capital structure?
Total Assets: Current - $750 million; Proposed $750 million
Debt: Current - $450 million; Proposed - $300 million
Equity: Current - $300 million; Proposed - $450 million
Common Stock Price: Current - $30; Proposed - $30
Number Of Shares: Current – 10,000,000; Proposed – 15,000,000
Interest Rate: Current – 12%; Proposed – 12%
P3.The Nutrex Corporation wants to calculate its weighted average cost of capital. Its target capital structure weights are 40% long-term debt and 60% common equity. The before-tax cost of debt is estimated to be 10% and the company is in the 40% tax bracket. The current risk-free interest rate is 8% on Treasury bills. The expected return on the market is 13% 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 weighted average cost of capital.