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a Your company, which is financed entirely with common equity, plans to manufacture a new product, a cell phone that can be worn like a wristwatch. Two robotic machines are available to make the phone, Machine A and Machine B. The price per phone will be $240.00 regardless of which machine is used to make it. The fixed and variable costs associated with the two machines are shown below, along with the capital (all equity) that must be invested to purchase each machine. The expected sales level is 35,000 units. Your company has tax loss carry-forwards that will cause its tax rate to be zero for the life of the project, so T = 0. How much higher or lower will the project's ROE be if you select the machine that produces the higher ROE, i.e., what is ROEB - ROEM? (Hint: Since the firm uses no debt and its tax rate is zero, ROE = EBIT/Required investment.) ##Machine## A Machine B Price per phone (P) $240.00 $240.00 Fixed costs (F) $1,000,000 $2,000,000 Variable cost/unit (V) $190.00 $140.00 Expected unit sales (0) 35,000 35,000 $2,500,000 $3,000,000 Required equity investment 22.60% 18.20% 24,40% O 24,20% 20.00% Monroe Inc. is an all-equity firm with 500,000 shares outstanding. It has $2,000,000 of EBIT, and EBIT is expected to remain constant in the future. The company pays out all of its earnings, so earnings per share (EPS) equal dividends per share (DPS), and its tax rate is 25%. The company is considering issuing $3,000,000 of 9.00% bonds and using the proceeds to repurchase stock. The risk-free rate is 4.5%, the market risk premium is 5.0%, and the firm's beta is currently 1.05. However, the CFO believes the beta would rise to 1.25 if the recapitalization occurs. Assuming the shares could be repurchased at the price that existed prior to the recapitalization, what would the price per share be following the recapitalization? (Hint: Po - EPS/r, because EPS - DPS.) O $34.47 $31.92 O $33.20 O $35.43 O $26.81 You were hired as the CFO of a new company that was founded by three professors at your university. The company plans to manufacture and sell a new product, a cell phone that can be worn like a wrist watch. The issue now is how to finance the company, with equity only or with a mix of debt and equity. The price per phone will be $250.00 regardless of how the firm is financed. The expected fixed and variable operating costs, along with other data, are shown below. How much higher or lower will the firm's expected ROE be if it uses 60% debt rather than only equity, i.e., what is ROEL - ROEU? Expected unit sales (0) Price per phone (P) Fixed costs (F) Variable cost/unit (V) Required investment % Debt Debt, $ Equity, $ Interest rate Tax rate 0% Debt, U 33,500 $250.00 $1,000,000 $200.00 $2,500,000 0.00% SO $2,500,000 NA 25.00% 60% Debt, 33,500 $250.00 $1,000,000 $200.00 $2,500,000 60.00% $1,500,000 $1,000,000 10.00% 25.00% 14.92% O 19.13% 17.40% 21.04% 20.85% Gator Fabrics Inc. currently has zero debt (i.e., Wd = 0). It is a zero growth company, and additional firm data are shown below. Now the company is considering using some debt, moving to the new capital structure indicated below. The money raised would be used to repurchase stock at the current price. It is estimated that the increase in risk resulting from the additional leverage would cause the required rate of return on equity to rise somewhat, as indicated below. If this plan were carried out, by how much would the WACC change, i.e., what is WACCold - WACCNew? Do not round your intermediate calculations. wa 80% Orig cost of equity, rs 10.0% We 20% New cost of equity = 15 11.0% Interest rate new Era 8.0% Tax rate 25% 3.33% O 3.00% O 2.55% 3.63% 2.40% Firm A is very aggressive in its use of debt to leverage up its earnings for common stockholders, whereas Firm NA is not aggressive and uses no debt. The two firms' operations are identical--they have the same total investor-supplied capital, sales, operating costs, and EBIT. Thus, they differ only in their use of financial leverage (wd). Both companies are small, so they are not subject to the interest deduction limitation. Based on the following data, how much higher or lower is A's ROE than that of NA, i.e., what is ROEA - ROENA? Do not round your intermediate calculations. Firm A's Data Firm NA's Data 50% Applicable to Both Firms Capital $155,000 EBIT $40,000 Tax rate 25% wa Int. rate wa Int, rate 0% 10% 12% O 10.25% 12.01% 10.35% 12.12% 12.84% You work for the CEO of a new company that plans to manufacture and sell a new product, a watch that has an embedded TV set and a magnifying glass crystal. The issue now is how to finance the company, with only equity or with a mix of debt and equity. Expected operating income is $180,000. The company is small, so it is not subject to the interest deduction limitation. Other data for the firm are shown below. How much higher or lower will the firm's expected ROE be if it uses some debt rather than all equity, i.e., what is ROEL - ROEU? Do not round your intermediate calculations 0% Debt, U 60% Debt, L Oper income (EBIT) $180,000 $180,000 Required investment $2,500,000 $2,500,000 % Debt 0.0% 60.0% S of Debt $0.00 $1,500,000 S of Common equity $2,500,000 $1,000,000 Interest rate NA 10.00% Tax rate 25% 25% -3.78% -3.15% 0 -2.84% 4.10% -3.31%

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