Project #31040 - Week 6

 

Hi, I will include the Excel worksheet and the link to the text I'm using (Ch 14, 15). Thank you

 

Brealey, R. A., Myers, S. C. & Allen, F. (2011). Principles of Corporate Finance, Concise Edition, (2nd ed.). New York, NY: McGraw-Hill Irwin.

 

 

 

 

 

 

 

 

 

 

Problem 14-2

               
                 

Assume that MM’s theory holds with taxes. There is no growth, and the $40 of debt is expected to be permanent. Assume a 40% corporate tax rate.
a. How much of the firm’s value is accounted for by the debt-generated tax shield?
b. How much better off will UF’s a shareholder be if the firm borrows $20 more and uses it to repurchase stock?

 
 
 
 
 
 
                 

Answer:

               
                 

Step 1:

 

 

           

 

Tax rate - Tc

F

           

a.

Permanent Debt - D

F

           

b.

Additional Debt - D

F

           
                 

Step 2:

 

 

           

 

Formula (in words)

Calculation

           

a. Tax shield

T

C

           

 

 

 

           

b. Tax shield

T

C

           

 

Benefit to Shareholders

C

 

TIP: difference between a and b

 

 

 

 

 

Problem 14-24

               
                   
                   

Some companies’ debt-equity targets are expressed not as a debt ratio, but as a target debt rating on a firm’s outstanding bonds. What are the pros and cons of setting a target rating, rather than a target ratio?

 
 
 
                   
                   

Answer:

                 
                   

Pros T

 
 
 
 
 
 
 
 
 
 
 
 
                   

Cons T

 
 
 
 
 
 
 
 
 
 
 
 
 

 

 

 

 

 

 

 

Problem 15-6

               
                   

A project costs $1 million and has a base-case NPV of exactly zero (NPV = 0). What is the project’s APV in the following cases?

a. If the firm invests, it has to raise $500,000 by a stock issue. Issue costs are 15% of net proceeds.
b. If the firm invests, its debt capacity increases by $500,000. The present value of interest tax shields on this debt is $76,000.

 
 
 
 
 
                   

Answers:

                 
                   

 

 

Formula (in words)

Calculation

     

a.

APV stock issue

T       

C

 

TIP: p.394

 

 

 

 

 

     

b.

APV debt increases

T      

C

 

TIP: p.393

 

 

 

 

 

 

Problem 15-9

               
                   
                   

The WACC formula seems to imply that debt is "cheaper" than equity--that is, that a firm with more debt could use a lower discount rate. Does this make sense? Explain briefly.

 
 
 
                   
                   

Answer:

                 
                   

T

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 

 

 

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