finc600 Week 6 Assignment - Homework Problems
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Complete the following problems in either
Microsoft Word or Excel.
Your work must be organized. Highlight your final answer.
Your work must be organized. Highlight your final answer.
Chapter 14
14-2:
Here are book- and market-value balance sheets
of the United Frypan Company (UF):
Book Market
Net Working Capital $20 $40
Debt Net Working Capital $20 $40 Debt
Long-term asset $80 $60
Equity Long-term Assets $140
$120 Equity
$100
$100 $160 $160
(The
middle-of-the-road party was founded in 1961 by Miller and Modigliani, always
referred to as “MM”, when they published a proof that dividend policy is
irrelevant in a world without taxes, transaction costs, or other market
imperfections. MM argued as follows.
Suppose your firm has settled on its investment program. You have a plan to
finance the investments with cash on hand, additional borrowing, and
reinvestment of future earnings. Any surplus cash is to be paid out as
dividends.) 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 shareholders
be if the firm borrows $20 more and uses it to repurchase stock?
14-3:
What is the relative tax advantage of corporate
debt if the corporate tax rate is Tc = .35, the personal tax rate is Tp = .35,
but all equity income is received as capital gains and escapes tax entirely
(TpE = 0)? How does the relative tax advantage change if the company decides to
pay out all equity income as cash dividends that are taxed at 15%?
Chapter 15
15-1:
Calculate the weighted-average cost of capital
(WACC) for Federated Junkyards of America, using the following information:
• Debt: $75,000,000 book value outstanding. The
debt is trading at 90% of book value. The yield to maturity is 9%.
• Equity: 2,500,000 shares selling at $42 per
share. Assume the expected rate of return on Federated’s stock is 18%.
• Taxes: Federated’s marginal tax rate is Tc =
.35.
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.
Show all your work to earn partial credit.
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