Assuming that there is an unlevered firm and a levered firm. The basic information is given by the following table. Table1: Information of the firms Unlevered firm Levered firm EBIT 10000 10000 Interest 0 3200 Taxable income Tax (tax rate: 34%) Net income CFFA Assuming that cost of debt =8%; unlevered cost of capital =10%; systematic risk of the asset is 1.5 Fill in the blanks What is the present value of the tax shield? What is the size of debt? Calculate the following values:a) value of unlevered firm; b) value of the levered firm; c) equity value; d) Cost of equity; e) cost of capital; f) systematic risk of the equity Suppose that the firm changes its capital structure so that the debt-to-equity ratio is 1.0, then recalculate the systematic risk of the equity Based on the results of question (4), if there are the following two mutually exclusive projects. What is the crossover required rate of return for the two projects? Based on the previous discussions, are you going to accept project A or B? Why?
Reporting Cash Flows
Reporting of cash flows means a statement of cash flow which is a financial statement. A cash flow statement is prepared by gathering all the data regarding inflows and outflows of a company. The cash flow statement includes cash inflows and outflows from various activities such as operating, financing, and investment. Reporting this statement is important because it is the main financial statement of the company.
Balance Sheet
A balance sheet is an integral part of the set of financial statements of an organization that reports the assets, liabilities, equity (shareholding) capital, other short and long-term debts, along with other related items. A balance sheet is one of the most critical measures of the financial performance and position of the company, and as the name suggests, the statement must balance the assets against the liabilities and equity. The assets are what the company owns, and the liabilities represent what the company owes. Equity represents the amount invested in the business, either by the promoters of the company or by external shareholders. The total assets must match total liabilities plus equity.
Financial Statements
Financial statements are written records of an organization which provide a true and real picture of business activities. It shows the financial position and the operating performance of the company. It is prepared at the end of every financial cycle. It includes three main components that are balance sheet, income statement and cash flow statement.
Owner's Capital
Before we begin to understand what Owner’s capital is and what Equity financing is to an organization, it is important to understand some basic accounting terminologies. A double-entry bookkeeping system Normal account balances are those which are expected to have either a debit balance or a credit balance, depending on the nature of the account. An asset account will have a debit balance as normal balance because an asset is a debit account. Similarly, a liability account will have the normal balance as a credit balance because it is amount owed, representing a credit account. Equity is also said to have a credit balance as its normal balance. However, sometimes the normal balances may be reversed, often due to incorrect journal or posting entries or other accounting/ clerical errors.
Assuming that there is an unlevered firm and a levered firm. The basic information is given by the following table.
Table1: Information of the firms
|
|
Unlevered firm |
Levered firm |
|
EBIT |
10000 |
10000 |
|
Interest |
0 |
3200 |
|
Taxable income |
|
|
|
Tax (tax rate: 34%) |
|
|
|
Net income |
|
|
|
CFFA |
|
|
Assuming that cost of debt =8%; unlevered cost of capital =10%; systematic risk of the asset is 1.5
- Fill in the blanks
- What is the present value of the tax shield?
- What is the size of debt?
- Calculate the following values:
a) value of unlevered firm; b) value of the levered firm; c) equity value; d)Cost of equity ; e) cost of capital; f) systematic risk of the equity - Suppose that the firm changes its capital structure so that the debt-to-equity ratio is 1.0, then recalculate the systematic risk of the equity
- Based on the results of question (4), if there are the following two mutually exclusive projects. What is the crossover required
rate of return for the two projects? - Based on the previous discussions, are you going to accept project A or B? Why?
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