Q1. Business and Financial RiskMM Model

Air Tampa has just been incorporated, and its board of directors is grappling with the question of optimal capital structure. The company plans to offer commuter air services between Tampa and smaller surrounding cities. Jaxair has been around for a few years, and it has about the same basic business risk as Air Tampa would have. Jaxair's market-determined beta is 1.4, and it has a current market value debt ratio (total debt to total assets) of 50% and a federal-plus-state tax rate of 35%. Air Tampa expects to be only marginally profitable at start-up; hence its tax rate would only be 20%. Air Tampa's owners expect that the total book and market value of the firm's stock, if it uses zero debt, would be $13 million. Air Tampa's CFO believes that the MM and Hamada formulas for the value of a levered firm and the levered firm's cost of capital should be used because zero growth is expected. (These are given in equations VL= VU+ VTax shield= VU+ TD, rsL= rsU+ (rsU- rd)(1 - T)(D/S), and b = bU[1 + (1 - T)(D/S)].)

A) Estimate the beta of an unlevered firm in the commuter airline business based on Jaxair's market-determined beta. (Hint:This is a levered beta; use Equation b = bU[1 + (1 - T)(D/S)] and solve for bU.) Do not round intermediate calculations. Round your answer to three decimal places.

B) Now assume that rd= rRF= 9% and that the market risk premium RPM= 6%. Find the required rate of return on equity for an unlevered commuter airline. Do not round intermediate calculations. Round your answer to three decimal places.

C) Air Tampa is considering three capital structures: (1) $1 million debt, (2) $4 million debt, and (3) $8 million debt. Estimate Air Tampa's rsfor these debt levels. Do not round intermediate calculations. Round your answers to two decimal places.

1. Air Tampa's rsfor $1 million debt is ????%
2. Air Tampa's rsfor $4 million debt is ????%
3. Air Tampa's rsfor $8 million debt is ????%

D) Calculate Air Tampa's rsat $8 million debt while assuming its federal-plus-state tax rate is now 40%. (Hint:The increase in the tax rate causes VUto drop to $11 million.) Do not round intermediate calculations. Round your answer to two decimal places.

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Q2. Break-even Point Schweser Satellites Inc. produces satellite earth stations that sell for $95,000 each. The firm's fixed costs, F, are $1.5 million, 50 earth stations are produced and sold each year, profits total $600,000, and the firm's assets (all equity financed) are $5 million. The firm estimates that it can change its production process, adding $5 million to assets and $450,000 to fixed operating costs. This change will reduce variable costs per unit by $11,000 and increase output by 24 units. However, the sales price on all units must be lowered to $85,000 to permit sales of the additional output. The firm has tax loss carryforwards that render its tax rate zero, its cost of equity is 12%, and it uses no debt.

A) What is the incremental profit?

B)To get a rough idea of the project's profitability, what is the project's expected rate of return for the next year (defined as the incremental profit divided by the investment)? Round your answer to two decimal places. ???%