This is a two-part question: We have a firm that needs $1000 to obtain a new machine for its business. It can either issue stock or bonds, or some combination of both. If it issues bonds it will have to pay $8.00 in interest for every $100 borrowed. Finally, assume the company will earn $150 in good years and $75 in bad years, with equal probability. The first part of the question is to (a) determine the payment to the equity holders under the following three scenarios: (i) the first is the firm uses 0% debt financing; (ii) the second is the firm uses 50% debt financing, and (iii) the third finds the firm using 80% debt financing. The second part of the question is to (b) determine the expected equity return (%) under each scenario.
What will be an ideal response?
The payment to the equity holders and the expected return are as follows, (i) for 0% debt financing, the payment is $75 - $150; with an expected return of 11.25%; (ii) with 50% debt financing the payment to equity holders will be $35 - $110; with an expected return of 14.5%; and finally, (iii) with 80% debt financing, the payment to the equity holders will be $11 - $86; with an expected return of 24.25%.
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a. True b. False Indicate whether the statement is true or false
The price of a good will tend to rise when
What will be an ideal response?