Upon completion of the Required Readings, write a thorough, well-planned narrative answer to the following discussion question. Rely on your Required Readings and the Lecture and Research Update for specific information to answer the discussion question, but turn to your original thoughts when asked to apply, evaluate, analyze, or synthesize the information. Your Discussion Question response should be both grammatically and mechanically correct, and formatted in the same fashion as the question itself. If there is a Part A, your response should identify a Part A, etc. In addition, you must appropriately cite all resources used in your responses and document in a bibliography using APA style.
Discussion Question 1 (50 points)
Respond to the following:
- Explain why a hotel company might have a higher proportion of debt in its capital structure relative to a drug company.
- According to Modigliani and Miller (M&M), in a world of perfect capital markets, what will be the expected equity return (or cost of equity) for a firm that has a cost of capital of 10 percent, a cost of debt of 6 percent, debt valued at $1.2 million, and equity valued at $1.0 million?
- Suppose a firm has $10 million in debt that it expects to hold in perpetuity. If the interest rate is 7 percent and the corporate tax rate is 35 percent, what is the value of the interest tax shield?
- What is the value of an all-equity firm that: has a dividend payout ratio of 100 percent, is expected to generate net income each year (forever) of $1 million, and has a required equity return (also the ROE) of 16 percent?
