AE 4 – FINANCIAL MARKETS

Activity #6 1
1. How does a firm’s financial structure differ from its capital structure?

2. Describe why capital structure is relevant to the value of the firm.

3. What are interest tax savings, and how do they affect the relevance of a firm’s
financing decisions?

4. What are financial distress costs, and how are they related to the firm’s financing
decisions?

5. How does the presence of financial distress costs, combined with the tax
deductibility of interest (and the resulting interest tax savings), affect a firm’s
weighted average cost of capital as the firm increases its use of debt financing
from no debt to higher and higher levels of debt?

6. What are agency costs, and how do they become a relevant consideration in
determining a firm’s capital structure?

7. Halmeoni Corn Dogs has ₩9 million in assets. The assets are funded with $3 million
of debt and ₩6 million in equity. The β of Halmeoni Corn Dogs is at 1.30.
Assuming a tax rate of 35%, how much is the unlevered beta of the company?

8. Han Ji-Pyeong Technologies is contemplating changing the capital structure of

the firm. The firm has $45,000,000 in total assets, earnings before interest and
taxes of $8,500,000, and is taxed at a rate of 40%.

a. Complete the following table showing the values of debt, equity, and the
total number of shares of common stock. The book value is $20 per share.

b. Complete the following table indicating the total debt and interest expense
for each level of indebtedness.

PAMANTASAN NG LUNGSOD NG VALENZUELA 1

COLLEGE OF BUSINESS AND ACCOUNTANCY
AE 4 – FINANCIAL MARKETS
Activity #6 2

c. Using an EBIT of $7,500,000, a 40% tax rate, and the information developed in
parts a and b, calculate the most likely earnings per share (EPS) for the firm at
each level of indebtedness.

d. Complete the following table showing the estimates of the value per share at
various levels of indebtedness. The estimates of required return are denoted
by rs.

e. Based on your answer in the previous parts, which debt ratio would you
recommend? Explain your answer.

PAMANTASAN NG LUNGSOD NG VALENZUELA 2

COLLEGE OF BUSINESS AND ACCOUNTANCY