Corporation and R Inc. are two companies with very similar characteristics. The only difference between the two companies is that Q Corporation is an unlevered firm, and R Inc. is a levered firm with debt of $3.5 million and cost of debt of 10%. Both companies have earnings before interest and taxes (EBIT) of $1.5 million and a marginal corporate tax rate of 35%. Q Corporation has a cost of capital of 15%. a. What is Q Corporation’s firm value?

Corporation and R Inc. are two companies with very similar characteristics. The only difference between the two companies is that Q Corporation is an unlevered firm, and R Inc. is a levered firm with debt of $3.5 million and cost of debt of 10%. Both companies have earnings before interest and taxes (EBIT) of $1.5 million and a marginal corporate tax rate of 35%. Q Corporation has a cost of capital of 15%. a. What is Q Corporation’s firm value?

Intermediate Financial Management (MindTap Course List)

13th Edition

ISBN:9781337395083

Author:Eugene F. Brigham, Phillip R. Daves

Publisher:Eugene F. Brigham, Phillip R. Daves

Chapter17: Dynamic Capital Structures And Corporate Valuation

Section: Chapter Questions

Problem 2P

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A5 7d Q Corporation and R Inc. are two companies with very similar characteristics. The only difference between the two companies is that Q Corporation is an unlevered firm, and R Inc. is a levered firm with debt of $3.5 million and cost of debt of 10%. Both companies have earnings before interest and taxes (EBIT) of $1.5 million and a marginal corporate tax rate of 35%. Q Corporation has a cost of capital of 15%. d. What is Q Corporation’s cost of equity capital?
A5 7g Q Corporation and R Inc. are two companies with very similar characteristics. The only difference between the two companies is that Q Corporation is an unlevered firm, and R Inc. is a levered firm with debt of $3.5 million and cost of debt of 10%. Both companies have earnings before interest and taxes (EBIT) of $1.5 million and a marginal corporate tax rate of 35%. Q Corporation has a cost of capital of 15%. g. What is R Inc.’s WACC?
A5 7c Q Corporation and R Inc. are two companies with very similar characteristics. The only difference between the two companies is that Q Corporation is an unlevered firm, and R Inc. is a levered firm with debt of $3.5 million and cost of debt of 10%. Both companies have earnings before interest and taxes (EBIT) of $1.5 million and a marginal corporate tax rate of 35%. Q Corporation has a cost of capital of 15%. c. What is R Inc.’s equity value?
A5 7i Q Corporation and R Inc. are two companies with very similar characteristics. The only difference between the two companies is that Q Corporation is an unlevered firm, and R Inc. is a levered firm with debt of $3.5 million and cost of debt of 10%. Both companies have earnings before interest and taxes (EBIT) of $1.5 million and a marginal corporate tax rate of 35%. Q Corporation has a cost of capital of 15%. i. What principle have you proven in this case?
A5 7e Q Corporation and R Inc. are two companies with very similar characteristics. The only difference between the two companies is that Q Corporation is an unlevered firm, and R Inc. is a levered firm with debt of $3.5 million and cost of debt of 10%. Both companies have earnings before interest and taxes (EBIT) of $1.5 million and a marginal corporate tax rate of 35%. Q Corporation has a cost of capital of 15%. e. What is R Inc.’s cost of equity capital?
A5 7f Q Corporation and R Inc. are two companies with very similar characteristics. The only difference between the two companies is that Q Corporation is an unlevered firm, and R Inc. is a levered firm with debt of $3.5 million and cost of debt of 10%. Both companies have earnings before interest and taxes (EBIT) of $1.5 million and a marginal corporate tax rate of 35%. Q Corporation has a cost of capital of 15%. f. What is Q Corporation’s WACC?
A5 7h Q Corporation and R Inc. are two companies with very similar characteristics. The only difference between the two companies is that Q Corporation is an unlevered firm, and R Inc. is a levered firm with debt of $3.5 million and cost of debt of 10%. Both companies have earnings before interest and taxes (EBIT) of $1.5 million and a marginal corporate tax rate of 35%. Q Corporation has a cost of capital of 15%. h. Compare the WACC of the two companies. What is your conclusion?
A5 7b Q Corporation and R Inc. are two companies with very similar characteristics. The only difference between the two companies is that Q Corporation is an unlevered firm, and R Inc. is a levered firm with debt of $3.5 million and cost of debt of 10%. Both companies have earnings before interest and taxes (EBIT) of $1.5 million and a marginal corporate tax rate of 35%. Q Corporation has a cost of capital of 15%. b. What is R Inc.’s firm value?
A5 7j Q Corporation and R Inc. are two companies with very similar characteristics. The only difference between the two companies is that Q Corporation is an unlevered firm, and R Inc. is a levered firm with debt of $3.5 million and cost of debt of 10%. Both companies have earnings before interest and taxes (EBIT) of $1.5 million and a marginal corporate tax rate of 35%. Q Corporation has a cost of capital of 15%. j. Both companies are now evaluating a project that requires an initial investment of $1.15 million, that will yield after tax cash inflows of $500,000 per year for the next three years. Assume that this project has the same risk level as each individual firm’s assets. Should Q Corporation invest in this project? Should R Inc. invest in this project?
N7 Wail Inc. is currently a firm that has 2 million shares of stock outstanding with a market price of $25 a share and outstanding debt of $30 million. The debt interest rate is 10%. Its cost of equity is 17 percent and the tax rate is 35 percent. For some reason related to one of the controlling shareholders’ preference, the company wants to get rid of all its debt. After recapitalization, what is the cost of equity?
33. There are two firms: Firm U and Firm L. Both firms have $100M total assets and $16M EBIT (earnings before interest and taxes). Firm U is an unleveraged firm without debt. Firm L is a leveraged firm with 50% of debt and 50% of common equity. The pre-tax cost of debt for Firm L is 8%. Both firms have 30% corporate tax rate. Calculate the return on equity (ROE) for firm U 9.6% 11.2% 12.0% 15.2% 34. Based on the information from Question 33, what’s the return on equity (ROE) for firm L 9.6% 13.2% 16.8% 19.2% Question 35 Based on the information from Question 33, what’s the difference of the total dollars paid to all investors in Firm L and Firm U $1.0 million $4.8 million $5.8 million $1.2 million
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