Skates Inc.

by | Jul 27, 2021 | Homework Help

You are analyzing Skates Inc., a firm that manufactures skateboards. The firm is currently unlevered and has a cost of equity of 12%. You estimate that Skates would have a cost of capital of 11% at its optimal debt ratio of 40%. The management, however, insists that it will not borrow the money because of the value of maintaining financial flexibility and has provided you with the following information:

Over the past 10 years, reinvestment (net capital expenditures + working capital investments) has amounted to 10% of firm value, on an annual basis. The standard deviation in this reinvestment has been 0.30. The firm has traditionally used only internal funding (net income + depreciation) to meet these needs, and these have amounted to 6% of firm value.In the most recent year, the firm earned $180 million in net income on a book value of equity of $1 billion, and it expects to earn these excess returns on new investments in the future. The riskless rate is 5%.

a. Calculate the

b. Estimate the value of financial flexibility as a percent of firm value on an annual basis.

c. Based on (b), would you recommend that Skates use its excess debt capacity?

Plagiarism-free and delivered on time!

We are passionate about delivering quality essays.

Our writers know how to write on any topic and subject area while meeting all of your specific requirements.

Unlike most other services, we will do a free revision if you need us to make corrections even after delivery.