Problem1: Copybold Corporation is a start-up firm considering two alternative capital structures--one is conservative and the other aggressive. The conservative capital structure calls for a D/A ratio = 0.25, while the aggressive strategy call for D/A = 0.75. Once the firm selects its target capital structure it envisions two possible scenarios for its operations: Feast or Famine. The Feast scenario has a 60 percent probability of occurring and forecast EBIT in this state is P60,000. The Famine state has a 40 percent chance of occurring and the EBIT is expected to be P20,000. Further, if the firm selects the conservative capital structure its cost of debt will be 10 percent, while with the aggressive capital structure its debt cost will be 12 percent. The firm will have P400,000 in total assets, it will face a 40 percent marginal tax rate, and the book value of equity per share under either scenario is P10.00 per share.

1. What is the difference between the EPS forecasts for Feast and Famine under the aggressive capital structure?

2. What is the difference between the EPS forecasts for Feast and Famine under the conservative capital structure?

Problem 2. Unlevered beta. Harley motors has P10,000,000 in assets, which were financed with P2,000,000 of debt and P8,000,000 in equity. Harleys beta is currently 1.2, and its tax rate is 40%. Use the Hamada equation to find Harleys unlevered beta, bU

Problem 3. Hamada Equation. Cyclone Software Co. is trying to establish its optimal capital structure. Its current capital structure consists of 25% debt and 75% equity.; however, the CEO believes that the firm should use more debt. The risk-free rate, rRF, is 5%; the market risk premium, RPM, is 6%; and the firms tax rate is 40%. Currently, Cyclones cost of equity is 14%, which is determined by the CAPM. What would be Cyclones estimated cost of equity if it changed its capital structure to 50% debt and 50% equity.

Problem 4. Optimal Capital Structure. Queen Industries, which has no debt outstanding, has a beta of 0.95 for its common stock. Management is considering a change in the capital structure to 40% debt and 60% equity. This change would increase the beta on the stock to 1.15, and the after-tax cost of debt will be 7.5%. The expected return on the equity market is 15%, and the risk-free rate is 5%. Recommend whether Queens management should proceed with the capital structure change.