EBK CORPORATE FINANCE
4th Edition
ISBN: 9780134202785
Author: DeMarzo
Publisher: VST
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Textbook Question
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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Students have asked these similar questions
(Use the following information for the next three questions). Consider a
world with taxes but no other market imperfections. BLT machinery has a debt
to equity ratio of 2/3. Its cost of equity is 20%, cost of debt is 4%, and tax rate is
35%. Assume that the risk-free rate is 4%, and market risk premium is 8%.
Suppose the firm repurchases stock and finances the repurchase with debt,
causing its debt to equity ratio to change to 3/2.
What is the firm's new cost of equity?
None of the choices
New cost of equity is 26.05%
New cost of equity is 23.59%
New cost of equity is 16.32%
New cost of equity is 28.00%
Your firm is targeting specific debt levels in the future. Cost of debt (RB) is 7%. The
risk-free rate is 4% and the expected market risk premium is 6%. Your firm's
unlevered (asset) beta is 1.
What is the appropriate rate to discount the interest tax shields associated with
your debt?
4.0%
6.00%
10.00%
12.57%
7.00%
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…
Chapter 16 Solutions
EBK CORPORATE FINANCE
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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