1. Think back to our discussion of a firm’s Beta:
a. Give an example of an industry which would have a high beta? Intuitively, why would that be the case?
b. If a firm has a levered beta which is twice that of its unlevered beta, what would this imply? Would it be cause for concern?
2. If the government were to lower the corporate tax rate, all other factors held constant, how would this affect a firm’s capital structure?
3. Assume the manager of ABC Corp makes the following statement: “To lower my cost of capital, I’ve decided to no longer buy equipment with debt financing anymore. Instead, I will only lease equipment – therefore I have no bank loans and my cost of debt is now zero. More so, since ABC Corp is privately held, and I personally own all the equity – ABC Corp cost of capital is now also zero!”.
a. Is the manager correct in his thinking?
4. XYZ Corp is planning to offer a special series of preferred shares. XYZ will set the dividend yield on these preferred shares so that they equal the return on its common shares. The risk-free rate in this economy is 4%, XYZ’s Beta is 1.2 and the market risk premium is 2%. Also, the par value of the preferred stock is $2. What dividend yield must XYZ offer?
Hint: the dividend yield will not be a number/constant.
