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Chapter 17 Questions V1

Decent Essays

Valuation and Capital Budgeting for the Levered Firm

Adjusted Present Value

17.1 Honda and GM are competing to sell a fleet of 25 cars to Hertz. Hertz fully depreciates all of its rental cars over five years using the straight-line method. The firm expects the fleet of 25 cars to generate $100,000 per year in earnings before taxes and depreciation for five years. Hertz is an all-equity firm in the 34-percent tax bracket. The required return on the firm’s unlevered equity is 10 percent, and the new fleet will not add to the risk of the firm.

a. What is the maximum price that Hertz should be willing to pay for the new fleet of cars if it remains an all-equity firm?
b. Suppose Hertz purchases the fleet from GM for $325,000, and Hertz …show more content…

These cash flows are expected to remain the same forever. The corporate tax rate is 40%.

a. Use the Flow-to-Equity approach to determine the value of Milano Pizza Club’s equity.
b. What is the total value of Milano Pizza Club?

Weighted Average Cost of Capital

17.6 If Wild Widgets, Inc., (WWI) were an all-equity firm, it would have a beta of 0.9. WWI has a target debt-to-equity ratio of 0.50. The expected return on the market portfolio is 16%, and Treasury bills currently yield 8% per annum. WWI one-year, $1,000 par value bonds carry a 7% annual coupon and are currently selling for $972.73. The yield on WWI’s longer term debt is equal to the yield on its one-year bonds. The corporate tax rate is 34%.

a. What is WWI’s cost of debt?
b. What is WWI’s cost of equity?
c. What is WWI’s weighted average cost of capital?

17.7 Bolero, Inc., has compiled the following information on its financing costs:

Bolero is in the 34% tax bracket and has a target debt-to-equity ratio of 100%. Bolero’s managers would like to keep the market values of short-term and long-term debt equal.

a. Calculate the weighted average cost of capital (rwacc) for Bolero using:
i. Book-value weights ii. Market-value weights iii. Target weights b. Explain the difference between the WACCs. Which is the correct WACC to use for project evaluation?

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