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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Chapter 16, Problem 13P
Your firm is considering issuing one-year debt, and has come up with the following estimates of the value of the interest tax shield and the probability of distress for different levels of debt:
Suppose the firm has a beta of zero, so that the appropriate discount rate for financial distress costs is the risk-free rate of 5%. Which level of debt above is optimal if, in the event of distress, the firm will have distress costs equal to
- a. $2 million?
- b. $5 million?
- c. $25 million?
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BBA Ltd has just issued $10 million in debt (at par or face value). The firm will pay interest only on this debt. BBA’s marginal tax rate is expected to be 30% for the foreseeable future.
a) Suppose BBA pays interest of 6% per year on its debt. What is its annual interest tax shield?
b) What is the present value of the interest tax shield, assuming the tax shield’s risk is the same as that of the loan?
c) Suppose instead that the interest rate on the debt is 5%. What is the present value of the interest tax shield in this case?
Ten years have passed since BBA issued $10 million in perpetual interest-only debt with a 6% annual coupon. Tax rates have remained the same at 30% but interest rates have dropped so BBA’s current cost of debt capital is 4%.
d) What is BBA’s annual interest tax shield now?
e) What is the present value of the interest tax shield now?
Suppose Mullens Corporation is considering three average-risk projects with the following costs and rates of return:
Project
Cost
Expected Rate of Return
1
$2,500
23.00%
2
$3,000
30.00%
3
$2,750
24.00%
Mullens estimates that it can issue debt at a rate of rd=20.00%rd=20.00% and a tax rate of T=25.00%T=25.00%. It can issue preferred stock that pays a constant dividend of Dp=$20.00Dp=$20.00 per year and at Pp=$200.00Pp=$200.00 per share.
Also, its common stock currently sells for P0=$16.00P0=$16.00 per share. The expected dividend payment of the common stock is D1=$4.00D1=$4.00 and the dividend is expected to grow at a constant annual rate of g=5.00%g=5.00% per year.
Mullens’ target capital structure consists of ws=75.00%ws=75.00% common stock, wd=15.00%wd=15.00% debt, and wp=10.00%wp=10.00% preferred stock.
1.According to the video, the after-tax cost of debt can be stated as ________________ . Plugging in the values for rdrd and (T)T yields an after-tax cost of…
Based in the U.S., Your firm faces a 25% chance of a potential loss of $20 million next year. If yourfirm implements new policies, it can reduce the chance of this loss by 10%, but these new policieshave an upfront cost of $300,000. Suppose the beta of the loss is 0, and the risk-free interest rate5%.ISa) If the firm is uninsured, what is the NPV of implementing the new policies?b) If the firm is fully insured, what is the NPV of implementing the new policies?c) Given your answer to question b), what is the actuarially fair cost of full insurance?d) What is the minimum-size deductible that would leave your firm with an incentive toimplement the new policies?e) What is the actuarially fair price of an insurance policy with the deductible in question d
Chapter 16 Solutions
Corporate Finance (4th Edition) (Pearson Series in Finance) - Standalone book
Ch. 16.1 - Prob. 1CCCh. 16.1 - Does the risk of default reduce the value of the...Ch. 16.2 - If a firm files for bankruptcy under Chapter 11 of...Ch. 16.2 - Why are the losses of debt holders whose claims...Ch. 16.3 - Prob. 1CCCh. 16.3 - True or False: If bankruptcy costs are only...Ch. 16.4 - Prob. 1CCCh. 16.4 - According to the trade-off theory, all else being...Ch. 16.5 - Prob. 1CCCh. 16.5 - Why would debt holders desire covenants that...
Ch. 16.6 - Prob. 1CCCh. 16.6 - Prob. 2CCCh. 16.7 - Coca-Cola Enterprises is almost 50% debt financed...Ch. 16.7 - Why would a firm with excessive leverage not...Ch. 16.7 - Describe how management entrenchment can affect...Ch. 16.8 - How does asymmetric information explain the...Ch. 16.8 - Prob. 2CCCh. 16.9 - Prob. 1CCCh. 16.9 - Prob. 2CCCh. 16 - Gladstone Corporation is about to launch a new...Ch. 16 - Baruk Industries has no cash and a debt obligation...Ch. 16 - When a firm defaults on its debt, debt holders...Ch. 16 - Prob. 4PCh. 16 - Prob. 5PCh. 16 - Suppose Tefco Corp. has a value of 100 million if...Ch. 16 - You have received two job offers. Firm A offers to...Ch. 16 - As in Problem 1, Gladstone Corporation is about to...Ch. 16 - Kohwe Corporation plans to issue equity to raise...Ch. 16 - Prob. 10PCh. 16 - Prob. 11PCh. 16 - Hawar International is a shipping firm with a...Ch. 16 - Your firm is considering issuing one-year debt,...Ch. 16 - Marpor Industries has no debt and expects to...Ch. 16 - Real estate purchases are often financed with at...Ch. 16 - On May 14, 2008, General Motors paid a dividend of...Ch. 16 - Prob. 17PCh. 16 - Consider a firm whose only asset is a plot of...Ch. 16 - Prob. 19PCh. 16 - Prob. 20PCh. 16 - Prob. 21PCh. 16 - Consider the setting of Problem 21 , and suppose...Ch. 16 - Consider the setting of Problems 21 and 22, and...Ch. 16 - You own your own firm, and you want to raise 30...Ch. 16 - Empire Industries forecasts net income this coming...Ch. 16 - Ralston Enterprises has assets that will have a...Ch. 16 - Prob. 27PCh. 16 - If it is managed efficiently, Remel Inc. will have...Ch. 16 - Which of the following industries have low optimal...Ch. 16 - According to the managerial entrenchment theory,...Ch. 16 - Info Systems Technology (IST) manufactures...Ch. 16 - Prob. 32PCh. 16 - Prob. 33P
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