Calculate the rate of return on equity

Assignment Help Corporate Finance
Reference no: EM13199234

a) Modigliani Inc. is a company that operates in a world with perfect capital markets (including no taxation). Its annual net operating income (NOI) is $1,000,000, and it is financed entirely by equity with a market value of 5 million.

The company is planning to buy back a substantial part of its own shares from its shareholders at the current market value of its shares. The buyback is to be funded entirely by the proceeds of a corporate bond issue. After the bond issue and buyback the company expects to have an equal amount of debt (D) and equity (E), i.e., D/E = 1.

Required:

i. Calculate the rate of return on equity given the present capital structure of the company (entirely equity-financed). Briefly explain your method and result.

ii. Calculate the rate of return on equity following the proposed capital-structure change assuming that (at the new D/E ratio) the company faces a cost of debt of 10 percent. Briefly explain your method and result, and comment on your assumptions.

iii. The company management approaches you for advice on its capital structure. Can you suggest an optimal capital structure that maximises the company value and minimises the cost of capital faced by the company?

b) Explain why companies tend to prefer internal to external funds when financing profitable investment projects. Draw on existing theories and relevant empirical findings.

Reference no: EM13199234

Questions Cloud

Changing of the technologies involved in their art : What extent do the artists contribute to the shaping and changing of the technologies involved in their art? What is the relation between artistic styles and the technology used for the respective art? Why and give an example?
What is the natural length l of the spring : If 5 J of work are needed to stretch a spring from 10 cm to 11 cm and 7 J are needed to stretch it from 11 cm to 12 cm, what is the natural length L of the spring?
State level of bias and stereotypes : You have the ability to choose three or four books for your students. Based on what you have learned in this course, how can you assess the level of bias and stereotypes in the contents of these texts?
How much money can she withdraw each month : Sharon has just retired, and has 1000000 dollars in her retirement account. The account will earn interest at an annual rate of 6 percent, compounded monthly.
Calculate the rate of return on equity : Explain why companies tend to prefer internal to external funds when financing profitable investment projects. Draw on existing theories and relevant empirical findings.
The feeding tube : June, a 34-year-old divorced woman diagnosed with severe anorexia, is hospitalized. Her doctors feel she may need to be placed on a feeding tube soon to save her life. Initially June agreed to the feeding tube. However, in the evening (before the tub..
Does gdp represent a violation of that equivalency : Suppose the only firm in an economy produces $10 worth of final goods in a year and only sells $9 of goods that year. We know that GDP can be equivalently be thought of as either total spending on new goods and services in an economy.
How many yards is the side of the initial square : A square's side is increased by 7 yards, which corresponds to an increase in the area by 217 square yards. How many yards is the side of the initial square?
Appendix g security assessments : Choose two settings from Ch. 9 of the text and list each setting. Then, complete the following tables. List five threats appropriate to the environment from the setting you chose.

Reviews

Write a Review

 

Corporate Finance Questions & Answers

  Prepare working capital forecasting statement of company

Prepare the Working Capital forecasting statement of the company and Materials are kept in store for 6 weeks, the processing time is 8 weeks and the finished goods are stored in godown for 90 days.

  Interpret the slope as a rate of change

Suppose you work as a business consultant. Corporations and governmental entities employed your firm to make recommendations for streamlining business operations, such as to create firms more fiscally sound.

  Calculate the variance for portfolio

Calculate the variance for each portfolio and then copy it down. This formula should have six values in it: 1 for Stock and what is the smallest standard deviation that you must accept?

  Find predicted maximum probable loss

Bell Curve, corporation, determines the expected rate and standard deviation of its total liability losses for forthcoming year as $10 million & $3 million respectively.

  Determine the receivables turnover

The Robinson Corporation has the following current assets & current liabilities for two years: Cash and marketable securities $ 50,000 for 2010 and 2011;

  Impact of the global economic crisis on business environment

This paper reviews the article of ‘the impact of the global economic crisis on the business environment' that is written by Roman & Sargu (2011).

  What npv and valuation would be implied

What would the founder's NPV value be according to Annabella, Krishnuvara, and Bob and what valuations do these three different expectations imply

  Discuss the additional requirements

Discuss the additional requirements that are placed on auditors from the Sarbanes-Oxley Act of 2002, and the actions of the Public Company Accounting Oversight Board (PCAOB).

  Prepare stockholders equity section

On March 1, 2010, Dora Company start operations with a charter it received from state that authorized 50,000 shares of dollar 4 par value common stock. Over next quarter, firm engaged in the transactions that follows;

  Calculate the expected returns and the risk premia

The Capital Asset Pricing Model (CAPM) holds, calculate the expected returns and the risk premia of the following two portfolios.

  Different growth rates distort a comparative ratio analysis

Different growth rates distort a comparative ratio analysis? Give some examples and how might these problems be alleviated?

  Calculate the expected return for the stock

A stock has a beta of 1.2 and the standard deviation of its returns is 25%. The market risk premium is five percent and the risk-free rate is four percent.

Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd