Quiz # 5 (Take-home)

Name:
Fin 445
Dr. Lee
Time:
(No partial credits)
1. From the information below, select the optimal capital structure for Minnow Entertainment
Company. (3 points)
a.
b.
c.
d.
e.

Debt = 40%; Equity = 60%; EPS = $2.95; Stock price = $26.50.

Debt = 50%; Equity = 50%; EPS = $3.05; Stock price = $28.90.
Debt = 60%; Equity = 40%; EPS = $3.18; Stock price = $31.20.
Debt = 80%; Equity = 20%; EPS = $3.42; Stock price = $30.40.
Debt = 70%; Equity = 30%; EPS = $3.31; Stock price = $30.00.

2. Which of the following statements is most correct? (3 points)

a. The capital structure that maximizes stock price is also the capital structure that
minimizes the weighted average cost of capital (WACC).
b. The capital structure that maximizes stock price is also the capital structure that
maximizes earnings per share.
c. The capital structure that maximizes stock price is also the capital structure that
maximizes the firms times interest earned (TIE) ratio.
d. Statements a and b are correct.
e. Statements b and c are correct.
3. Simon Software Co. is trying to estimate its optimal capital structure. Right now, Simon has a
capital structure that consists of 20 percent debt and 80 percent equity. (Its D/E ratio is 0.25.) The
risk-free rate is 6 percent and the market risk premium, k M kRF, is 5 percent. Currently the
companys cost of equity, which is based on the CAPM, is 12 percent and its tax rate is 40
percent. What would be Simons estimated cost of equity if it were to change its capital structure
to 50 percent debt and 50 percent equity? (7 points)
a.
b.
c.
d.
e.

14.35%
30.00%
14.72%
15.60%
13.64%

4. Zippy Pasta Corporation (ZPC) has a constant growth rate of 7 percent. The company retains
30 percent of its earnings to fund future growth. ZPCs expected EPS (EPS 1) and ks for various
capital structures are given below. What is the optimal capital structure for ZPC? (7 points)
Debt/Total Assets
20%
30
40
50
70

a.
b.
c.
d.
e.

Debt/Total Assets = 20%

Debt/Total Assets = 30%
Debt/Total Assets = 40%
Debt/Total Assets = 50%
Debt/Total Assets = 70%

Expected EPS
$2.50
3.00
3.25
3.75
4.00

ks
15.0%
15.5
16.0
17.0
18.0