FINC 500 Homework Assignment for Week 7:

FINC 500 Homework Assignment for Week 7:

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For Week 7, please turn in the answers to the following questions:

1.       When analysts use the term “capital structure,” what are they referring to?

2.       Why does capital structure affect the market value of a firm?

3.       Define “total risk” as it is used in capital structure theory.  How is total risk measured?

4.       The forecast for your firm indicates there's a 20% chance that Net Income will be $200,000, a 50% chance it will be $300,000, and a 30% chance it will be $400,000.

a.       Given these conditions and your answer to part a, what is the standard deviation of the Net Income estimate?

b.      Given your answers to parts a & b, what is the coefficient of variation (CV) of the net income estimate?

5.       What’s the difference between business risk and financial risk?

6.       Assume your firm is zero-growth and pays all its net income in dividends each year  Also assume your firm can borrow money when it needs to at an interest rate of 6%.  Currently your firm’s cost of equity (Rs) is 10%, but if any money is borrowed that cost will rise to 11%.  Sales this year are expected to be $500,000 and operating costs are expected to be $400,000.  Your firm’s effective tax rate is 40%.  Given these conditions, what is the current value of your firm?  What will be the new value of your firm if it takes on $250,000 in debt?