cost of debt 8% unlevered cost of capital 10% systematic risk of asset 1.5 1) Unlevered Firm Levered Firm EBIT 10000 10000 Interest 0 3200 Taxable Income 10000 6800 34% Tax 3400 2312 Net Income 6600 4488 CFFA 0 -3200 2) PV of the tax shield? Value of levered firm 3200 tax rate 34% (value of levered firmtax rate)/(1+cost of debt) PV of tax shield 1007.41 value of levered firm/cost of debt 3) Size of debt 40000 4) a) EBIT(1-T)/cost of capital Value of unlevered firm 66000 b) value of unlevered firm+Taxsize of debt Value of levered firm 79600 c) total value of unlevered firm-debt Equity value 39600 d) cost of equity cost of capital+(debt/equity)(cost of capital-cost of debt) cost of equity 12.02% e) wacc formula equity/value of levered firmcost of equity+debt/value of levereed firmcost of debt(1-T) cost of capital (levered) 8.63% f) systematic risk of asset(1+((1-T)*(debt/equity))) systematic risk of equity 2.5 Hi I really need help with question 5! Thank you so much! 5. 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

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 7P

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Question

cost of debt	8%
unlevered cost of capital	10%
systematic risk of asset	1.5
1)
		Unlevered Firm	Levered Firm
	EBIT	10000	10000
	Interest	0	3200
	Taxable Income	10000	6800
34%	Tax	3400	2312
	Net Income	6600	4488
	CFFA	0	-3200

2)	PV of the tax shield?

	Value of levered firm	3200
	tax rate	34%
		(value of levered firm*tax rate)/(1+cost of debt)
	PV of tax shield	1007.41

		value of levered firm/cost of debt
3)	Size of debt	40000

4)
a)		EBIT(1-T)/cost of capital
	Value of unlevered firm	66000

b)		value of unlevered firm+Tax*size of debt
	Value of levered firm	79600

c)		total value of unlevered firm-debt
	Equity value	39600

d)	cost of equity	cost of capital+(debt/equity)(cost of capital-cost of debt)
	cost of equity	12.02%

e)		wacc formula
		equity/value of levered firmcost of equity+debt/value of levereed firmcost of debt*(1-T)
	cost of capital (levered)	8.63%

f)		systematic risk of asset(1+((1-T)(debt/equity)))
	systematic risk of equity	2.5

Hi I really need help with question 5! Thank you so much!

5. 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

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Expert Answer

Step 1

Systematic risk of the equity is calculated using the unlevered systematic risk and debt equity ratio of 1 as below.

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Step 2

Answer: levered beta or systematic risk of the equity when debt to equity ratio is 1 would be 2.49.

6) 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.

Year Proj A Cash Flow Proj B CashFlow

0 - 75,000 -75,000

1 26,300 24,000

2 29,500 26,900

3 45,300 51,300

7) Based on the previous discussion, are you going to accept project A or B? Why?

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