Question 1 - Capital structure Granby Biotech has no debt financing and an asset beta of...

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Question 1 - Capital structure Granby Biotech has no debt financing and an asset beta of 0.7. Assume a risk free rate of 5% and that the CAPM holds and the expected return on the market portfolio is 13%. REQUIRED: (a) There are no corporate taxes or costs of financial distress or bankruptcy [B₂ = (1 + ?/?) × B A]. Assume that the company repurchases its equity by issuing debt at the risk free rate of 5%. As more debt is issued the return on debt does not change. Calculate the WACC, return on equity and return on debt at 0%, 20%, 40%, 60%, 80% and 99% debt and plot these figures on a graph. (b) Explain your results with reference to the Modigliani Miller capital structure irrelevancy theorem. (c) Now assume that debt attracts corporation tax relief at 35%. Recalculate the return on equity [again, assume ₂ = (1 + ?/?) x B1, the return on debt and the WACC at 0% debt, 20%, 40%, 60%, 80%, 100%. Plot your results on a graph. (d) What conclusions do you draw from your graph at (c) above. (e) How do personal taxes and costs of financial distress affect the conclusions drawn at (d) above. Question 1 - Capital structure Granby Biotech has no debt financing and an asset beta of 0.7. Assume a risk free rate of 5% and that the CAPM holds and the expected return on the market portfolio is 13%. REQUIRED: (a) There are no corporate taxes or costs of financial distress or bankruptcy [B₂ = (1 + ?/?) × B A]. Assume that the company repurchases its equity by issuing debt at the risk free rate of 5%. As more debt is issued the return on debt does not change. Calculate the WACC, return on equity and return on debt at 0%, 20%, 40%, 60%, 80% and 99% debt and plot these figures on a graph. (b) Explain your results with reference to the Modigliani Miller capital structure irrelevancy theorem. (c) Now assume that debt attracts corporation tax relief at 35%. Recalculate the return on equity [again, assume ₂ = (1 + ?/?) x B1, the return on debt and the WACC at 0% debt, 20%, 40%, 60%, 80%, 100%. Plot your results on a graph. (d) What conclusions do you draw from your graph at (c) above. (e) How do personal taxes and costs of financial distress affect the conclusions drawn at (d) above.

Answer rating: 100% (QA)

To calculate the Weighted Average Cost of Capital WACC return on equity and return on debt at different levels of debt well follow these steps 1 Calculate the unlevered beta using the formula textUnle... View the full answer