Corporate Finance (4th Edition) (Pearson Series in Finance) - Standalone book

4th Edition

ISBN: 9780134083278

Author: Jonathan Berk, Peter DeMarzo

Publisher: PEARSON

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Textbook Question

Chapter 15, Problem 23P

Garnet Corporation is considering issuing risk-free debt or risk-free preferred stock. The tax rate on interest income is 35%, and the tax rate on dividends or capital gains from preferred stock is 15%. However, the dividends on preferred stock are not deductible for corporate tax purposes, and the corporate tax rate is 40%.

a. If the risk-free interest rate for debt is 6%, what is the cost of capital for risk-free preferred stock?
b. What is the after-tax debt cost of capital for the firm? Which security is cheaper for the firm?
c. Show that the after-tax debt cost of capital is equal to the preferred stock cost of capital multiplied by (1- τ *).

Definition Definition Tax imposed by the government on the "gain" or increase in the value of an asset at the time of its sale by the owner. Capital gain is computed based on the purchase price and sale price of the asset. If the sale price of the asset is more than the purchase price, there is a gain on the sale of asset. A tax is imposed on such gain in accordance with the applicable tax rates at the time of sale.

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Chapter 15, Problem 22P

Chapter 15, Problem 24P

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Chapter 15 Solutions

Corporate Finance (4th Edition) (Pearson Series in Finance) - Standalone book

Ch. 15.1 - With corporate income taxes, explain why a firms...Ch. 15.1 - Prob. 2CC Ch. 15.2 - With corporate taxes as the only market...Ch. 15.2 - How does leverage affect a firms weighted average...Ch. 15.3 - How can shareholders benefit from a leveraged...Ch. 15.3 - How does the interest tax shield enter into the...Ch. 15.4 - Prob. 1CC Ch. 15.4 - How does this personal tax disadvantage of debt...Ch. 15.5 - How does the growth rate of a firm affect the...Ch. 15.5 - Do firms choose capital structures that fully...

Ch. 15 - Prob. 1P Ch. 15 - Grommit Engineering expects to have net income...Ch. 15 - Suppose the corporate tax rate is 40%. Consider a...Ch. 15 - Braxton Enterprises currently has debt outstanding...Ch. 15 - Your firm currently has 100 million in debt...Ch. 15 - Arnell Industries has just issued 10 million in...Ch. 15 - Prob. 7P Ch. 15 - Prob. 8P Ch. 15 - Safeco Inc. has no debt, and maintains a policy of...Ch. 15 - Rogot Instruments makes fine violins and cellos....Ch. 15 - Rumolt Motors has 30 million shares outstanding...Ch. 15 - Summit Builders has a market debt-equity ratio of...Ch. 15 - NatNah, a builder of acoustic accessories, has no...Ch. 15 - Restex maintains a debt-equity ratio of 0.85, and...Ch. 15 - Acme Storage has a market capitalization of 100...Ch. 15 - Milton Industries expects free cash flow of 5...Ch. 15 - Prob. 17P Ch. 15 - Kurz Manufacturing is currently an all-equity firm...Ch. 15 - Rally, Inc., is an all-equity firm with assets...Ch. 15 - Prob. 20P Ch. 15 - Facebook, Inc. had no debt on its balance sheet in...Ch. 15 - Markum Enterprises is considering permanently...Ch. 15 - Garnet Corporation is considering issuing...Ch. 15 - Suppose the tax rate on interest income is 35%,...Ch. 15 - With its current leverage, Impi Corporation will...Ch. 15 - Colt Systems will have EBIT this coming year of 15...Ch. 15 - PMF, Inc., is equally likely to have EBIT this...

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Solution Summary: The author explains that the cost of capital for risk-free preferred stock is 4.59%.

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Chapter 15 Solutions