Assessing Future Financial Needs
1. Explain why a hotel company might have a higherproportion of debt in its capital structure relative to a drug company.
2. According to Modigliani and Miller (M&M), ina world of perfect capital markets, what will be the expected equity return (orcost of equity) for a firm that has a cost of capital of 10 percent, a cost ofdebt of 6 percent, debt valued at $1.2 million, and equity valued at $1.0million?
3. Suppose a firm has $10 million in debt that itexpects to hold in perpetuity. If the interest rate is 7 percent and thecorporate tax rate is 35 percent, what is the value of the interest tax shield?
4. What is the value of an all-equity firm that:has a dividend payout ratio of 100 percent, is expected to generate net incomeeach year (forever) of $1 million, and has a required equity return (also theROE) of 16 percent?
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