Rate of Return On Equity (ROE) – Case 18

Please work on Case 18 from the Casebook.  Answer the following questions.

 

1. Given the information given in exhibit 18.1
2. Calculate the rate of return on equity (ROE) for each of the different scenarios of financing,
3. Calculate the standard deviation of the ROE for each scenario of financing and the coefficient of variation. What do these numbers tell you?
4. Calculate the business risk under each scenario, assuming that under this technique, it is equal to the difference between the overall standard deviation minus the standard deviation under all equity financing.
5. Calculate the estimated value of equity under each scenario.

 

2. Based on the information in the case,
3. Calculate the Corporate Cost of Capital (CCC) for each one of the scenarios, based on the value of equity calculated above and the cost of debt under each scenario. What is the optimal cost of capital?
4. Graph both the estimated stock price and the Corporate Cost of Capital and describe heir relationship.

 

3. Assuming debt financing of $7,500,000, and other information given in the case,
4. What is the value of the levered firm under Modigliani and Miller (MM)?
5. What is the value of the levered firm under the Miller model?