Fundamentals of Corporate Finance (Special Edition for Rutgers Business School)
11th Edition
ISBN: 9781308509853
Author: Ross, Westerfield, Jordan
Publisher: McGraw Hill
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Chapter 14, Problem 10QP
Taxes and WACC [LO3] Lannister Manufacturing has a target debt–equity ratio of .35. Its
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A company currently has a WACC of 10.6 percent and no debt. The tax rate is 21 percent.
a. What is the company’s current cost of equity?
b. If the firm converts to 40 percent debt with a cost of 6%, what will its cost of equity be? And the WACC?
c. If the firm converts to 60 percent debt with a cost of 6% , what will its cost of equity be? And the WACC?
d. What can you conclude from the values of the cost of equity and WACC obtained in b. and c.
Question 28:
MM and Taxes Solar Industries has a debt-equity ratio of 1.25. Its WACC is 7.8 percent, and
its cost of debt is 4.7 percent. The corporate tax rate is 21 percent.
What is the company’s cost of equity capital?
What is the company’s unlevered cost of equity capital?
What would the cost of equity be if the debt-equity ratio were 2? What if it were 1? What if it were zero?
D6)
Suppose there are perfect capital markets with taxes. Investors expect a company to have $120 earnings before interest and taxes in one year. This company has a 25% tax rate, $100 market value of debt, and 20 shares outstanding. This company’s net working capital, depreciation expense, and capital expenditures are all expected to be zero in perpetuity. Investors expect this company to have the same earnings before interest and taxes, market value of debt, tax rate, and number of shares outstanding in perpetuity. The firm’s unlevered cost of equity is 8% and its cost of debt is 5%. Based on this information, what amount would you expect this company’s share price to be closest to?
$5
$20
$40
$80
$100
$200
$400
Chapter 14 Solutions
Fundamentals of Corporate Finance (Special Edition for Rutgers Business School)
Ch. 14.1 - What is the primary determinant of the cost of...Ch. 14.1 - What is the relationship between the required...Ch. 14.2 - What do we mean when we say that a corporations...Ch. 14.2 - Prob. 14.2BCQCh. 14.3 - Why is the coupon rate a bad estimate of a firms...Ch. 14.3 - How can the cost of debt be calculated?Ch. 14.3 - How can the cost of preferred stock be calculated?Ch. 14.4 - Prob. 14.4ACQCh. 14.4 - Prob. 14.4BCQCh. 14.4 - Under what conditions is it correct to use the...
Ch. 14.5 - Prob. 14.5ACQCh. 14.5 - Prob. 14.5BCQCh. 14.6 - Prob. 14.6ACQCh. 14.6 - Why do you think we might prefer to use a ratio...Ch. 14.7 - What are flotation costs?Ch. 14.7 - How are flotation costs included in an NPV...Ch. 14 - A firm has paid dividends of 1.02, 1.10, 1.25, and...Ch. 14 - Prob. 14.3CTFCh. 14 - Why is the tax rate applied to the cost of debt...Ch. 14 - What approach to a projects costs of capital...Ch. 14 - What is the flotation cost of equity for a firm...Ch. 14 - WACC [LO3] On the most basic level, if a firms...Ch. 14 - Book Values versus Market Values [LO3] In...Ch. 14 - Project Risk [LO5] If you can borrow all the money...Ch. 14 - Prob. 4CRCTCh. 14 - DCF Cost of Equity Estimation [LO1] What are the...Ch. 14 - SML Cost of Equity Estimation [LO1] What are the...Ch. 14 - Prob. 7CRCTCh. 14 - Cost of Capital [LO5] Suppose Tom OBedlam,...Ch. 14 - Company Risk versus Project Risk [LO5] Both Dow...Ch. 14 - Divisional Cost of Capital [LO5] Under what...Ch. 14 - Calculating Cost of Equity [LO1] The Absolute Zero...Ch. 14 - Calculating Cost of Equity [LO1] The Graber...Ch. 14 - Calculating Cost of Equity [LO1] Stock in Daenerys...Ch. 14 - Estimating the DCF Growth Rate [LO1] Suppose...Ch. 14 - Prob. 5QPCh. 14 - Calculating Cost of Debt [LO2] Drogo, Inc., is...Ch. 14 - Calculating Cost of Debt [LO2] Jiminys Cricket...Ch. 14 - Prob. 8QPCh. 14 - Calculating WACC [LO3] Mullineaux Corporation has...Ch. 14 - Taxes and WACC [LO3] Lannister Manufacturing has a...Ch. 14 - Finding the Target Capital Structure [LO3] Famas...Ch. 14 - Book Value versus Market Value [LO3] Dinklage...Ch. 14 - Calculating the WACC [LO3] In Problem 12, suppose...Ch. 14 - WACC [LO3] Fyre, Inc., has a target debtequity...Ch. 14 - Prob. 15QPCh. 14 - Prob. 16QPCh. 14 - SML and WACC [LO1] An all-equity firm is...Ch. 14 - Calculating Flotation Costs [LO4] Suppose your...Ch. 14 - Calculating Flotation Costs [LO4] Caughlin Company...Ch. 14 - WACC and NPV [LO3, 5] Scanlin, Inc., is...Ch. 14 - Flotation Costs [LO4] Pardon Me, Inc., recently...Ch. 14 - Calculating the Cost of Debt [LO2] Ying Import has...Ch. 14 - Calculating the Cost of Equity [LO1] Epley...Ch. 14 - Adjusted Cash Flow from Assets [LO3] Ward Corp. is...Ch. 14 - Adjusted Cash Flow from Assets [LO3] In the...Ch. 14 - Prob. 26QPCh. 14 - Prob. 27QPCh. 14 - Flotation Costs and NPV [LO3, 4] Photochronograph...Ch. 14 - Flotation Costs [LO4] Sheaves Corp. has a...Ch. 14 - Project Evaluation [LO3, 4] This is a...Ch. 14 - Prob. 31QPCh. 14 - Prob. 1MCh. 14 - Cost of Capital for Swan Motors You have recently...Ch. 14 - Prob. 3MCh. 14 - Cost of Capital for Swan Motors You have recently...Ch. 14 - Cost of Capital for Swan Motors You have recently...
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- 45. Which of the following is an example of a capital market instrument? a. Commercial Paper. b. Treasury bills. c. Preferred stock. d. Banker’s acceptances. 46. Which of the following ratios will increase as a firm uses more financial leverage? a. The debt-to-equity ratio b. The inventory turnover c. The time-interest-earned ratio 47 You need $2,000 to buy a new stereo for your car. If you have $800 to invest at 5 percent compounded annually, how long will you have to wait to buy the stereo? a. 18.78 years. b. 14.58 years. c. 8.42 years. d. 6.58 years.arrow_forwardA5 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 $500,000 per year for the next three years. Assume that this project has the same risk level as each individual firm’s assets. Should Q Corporation invest in this project? Should R Inc. invest in this project?arrow_forward20. Novavax, Inc. has a market value of equity of 44524$. It borrows 8388$ at 6.7%. If the unlevered cost of equity is 11.5%, and corporate tax rate is 21% what is the Novavax, Inc.'s cost of equity capital?arrow_forward
- p5 In a world with taxes, the value of a leveraged firm equals the value of an unleveraged firm plus: the present value of its debt. the present value of the interest tax shield. the present value of its future cash flows. none of the above.arrow_forward17. Zaman Pharmaceutical’s cost of debt is 9%. The risk–free rate of interest is 5%. The expected return on the market portfolio is 8%. After effective taxes, Zaman’s effective tax rate is 30%. Its optimal capital structure is 60% debt and 40% equity. a. If Zaman’s beta is estimated at 1.3, what is its weighted average cost of capital? b. If Zaman’s beta is estimated at 0.7, significantly lower because of the continuing profit prospects in the global energy sector, what is its weighted average cost of capital?arrow_forwardHw.16. Blue Angel, Inc., a private firm in the holiday gift industry, is considering a new project. The company currently has a target debt–equity ratio of .45, but the industry target debt–equity ratio is .40. The industry average beta is 1.30. The market risk premium is 8 percent, and the risk-free rate is 6 percent. Assume all companies in this industry can issue debt at the risk-free rate. The corporate tax rate is 35 percent. The project requires an initial outlay of $676,000 and is expected to result in a $96,000 cash inflow at the end of the first year. The project will be financed at the company’s target debt–equity ratio. Annual cash flows from the project will grow at a constant rate of 6 percent until the end of the fifth year and remain constant forever thereafter. Calculate the NPV of the project.arrow_forward
- chapter 9 #4 Assume that a company borrows at a cost of 0.08. Its tax rate is 0.35. What is the minimum after-tax cost of capital for a certain cash flow if 100 percent debt is used? ____________________ 100 percent common stock? ____________________ (assume that the stockholders will accept 0.08)arrow_forwardfor question 9 Ch. 13. For questions 7, 8, and 9, use the following information: 7.) Consider a firm whose debt has a market value of $35 million and whose stock has a market value of $55 million. The firm pays a 7 percent rate of interest on its new debt and has a beta of 1.23. The corporate tax rate is 21%. Assume that the security market line holds, that the risk premium on the market is 10.5 percent, and that the current Treasury bill is rate is 1 percent. What is the aftertax cost of debt? Format as a percentage and round to two places past the decimal point as "X.XX" 5.53 8.) Consider a firm whose debt has a market value of $35 million and whose stock has a market value of $55 million. The firm pays a 7 percent rate of interest on its new debt and has a beta of 1.23. The corporate tax rate is 21%. Assume that the security market line holds, that the risk premium on the market is 10.5 percent, and that the current Treasury bill is rate is 1 percent. Using the pretax cost of…arrow_forward5 Dye Industries currently uses no debt, but its new CFO is considering changing the capital structure to 40.0% debt (wd) by issuing bonds and using the proceeds to repurchase and retire common shares so the percentage of common equity in the capital structure (wc) = 1 – wd. Given the data shown below, by how much would this recapitalization change the firm's cost of equity, i.e., what is rL - rU?Risk-free rate, rRF 6.00% Tax rate, T 30%Market risk premium, RPM 4.00% Current wd 0%Current beta, bU 1.15 Target wd 40% Group of answer choices 1.66% 2.15% 2.23% 2.02% 2.45% 1.84%arrow_forward
- Ch. 13. For questions 7, 8, and 9, use the following information: Consider a firm whose debt has a market value of $35 million and whose stock has a market value of $55 million. The firm pays a 7 percent rate of interest on its new debt and has a beta of 1.23. The corporate tax rate is 21%. Assume that the security market line holds, that the risk premium on the market is 10.5 percent, and that the current Treasury bill is rate is 1 percent. What is the aftertax cost of debt? Format as a percentage and round to two places past the decimal point as "X.XX"arrow_forwardConsider an economy with distress costs and corporate tax rates. Consider further a firm with EBIT corporate tax rate tau 0.3. What is the optimal leverage ratio (D/V)? 100 constant, rA 10%, rD 5%, distress costs 0.0005*D^2,arrow_forward14. Assume the marginal corporate tax rate is 28%. The firm has no debt in its capital structure. It is valued at $92,393,301. What would be the value of the firm if it issued $50,000,000 in perpetual debt and repurchased the same amount of equity?arrow_forward
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What is WACC-Weighted average cost of capital; Author: Learn to invest;https://www.youtube.com/watch?v=0inqw9cCJnM;License: Standard YouTube License, CC-BY