Corporate Finance (4th Edition) (Pearson Series in Finance) - Standalone book
4th Edition
ISBN: 9780134083278
Author: Jonathan Berk, Peter DeMarzo
Publisher: PEARSON
expand_more
expand_more
format_list_bulleted
Videos
Textbook Question
Chapter 16, Problem 15P
Real estate purchases are often financed with at least 80% debt. Most corporations, however, have less than 50% debt financing. Provide an explanation for this difference using the trade-off theory.
Expert Solution & Answer
Want to see the full answer?
Check out a sample textbook solution
Students have asked these similar questions
Wilmore Company Limited is a levered entity with percentage of debt out of total capital being 40%. If the interest rate on a bank loan is 10%, the tax rate is 20%, and the cost of equity is as computed in (a), what will be the after tax cost of debt?
Company A is financed with 90 percent debt, whereas Company B, which has the same amount of total assets, is financed entirely with equity. Both companies have a marginal tax rate of 35 percent. Which of the following statements is correct?
A. If the two companies have the same basic earning power (BEP), Company B will have a higher return on assets.
B. If the two companies have the same return on assets, Company B will have a higher return on equity.
C. If the two companies have the same level of sales and basic earning power (BEP), Company B will have a lower profit margin.
D. All of the answers above are correct.
E. None of the answers above is correct.
Butler, Inc., has a target debt-equity ratio of 1.40. Its WACC is 9.5 percent, and the tax rate is 23 percent.
a.
If the company’s cost of equity is 13.3 percent, what is its pretax cost of debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
b.
If instead you know that the aftertax cost of debt is 5.5 percent, what is the cost of equity? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
a. Pretax cost of debt:____%
b. Cost of equity:____%
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
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Similar questions
- Starset, Incorporated, has a target debt-equity ratio of 0.76. Its WACC is 10.5 percent, and the tax rate is 32 percent. If the company's cost of equity is 14.5 percent, what is the pretax cost of debt? If instead you know that the aftertax cost of debt is 6.7 percent, what is the cost of equity?arrow_forwardGarwryk, inc., which is financed with debt and equity, presently has a debt ratio of 78 percent. What is the firm’s equity multiplier? How is the equity multiplier related to the firm’s use of debt financing (i.e., if the firm increased its use of debt financing would this increase or decrease its equity multiplier)? Explain How is the multiplier related to the firm’s use of debt financing (i.e., if the firm’s increase its use of debt financing would this increase or decrease its equity multiplier)? Explainarrow_forwardA corporation plans to buy out a supplier and needs $2 million in new capital to do so. The proportion of equity to debt financing will be 40:60 for the acquisition. The current cost of equity capital is 14% after taxes, and it is 12% before taxes for debt financing. The effective income-tax rate is 55% . What is the minimum amount of before-tax earnings necessary per year from the purchase to justify raising the required capital ? What minimum after-tax earnings should be expected?arrow_forward
- Bulldogs Inc., which has 20% income tax rate, is funded by debt and common equity. The equity ratio of the company is 70% while the weighted average cost of capital is 20.75%. The cost of equity, which is based on the readily available data, is calculated using cost of retained earnings at 12.50%. What is the cost of debt after the effect of tax shield?arrow_forwardUrsala, Incorporated, has a target debt-equity ratio of 1.25. Its WACC is 8.4 percent and the tax rate is 23 percent. If the company’s cost of equity is 12.4 percent, what is its pretax cost of debt? If instead you know that the aftertax cost of debt is 3.6 percent, what is the cost of equity?arrow_forwardStarset, Inc., has a target debt-equity ratio of .80. Its WACC is 9.1 percent, and the tax rate is 25 percent. a.If the company's cost of equity is 13 percent, what is its pretax cost of debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) b.If instead you know that the aftertax cost of debt is 5.8 percent, what is the cost of equity?arrow_forward
- Ursala, Incorporated, has a target debt-equity ratio of 1.20. Its WACC is 8.7 percent, and the tax rate is 25 percent. a. If the company’s cost of equity is 13 percent, what is its pretax cost of debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) b. If instead you know that the aftertax cost of debt is 5.8 percent, what is the cost of equity?arrow_forwardViserion, Incorporated, is trying to determine its cost of debt. The firm has a debt issue outstanding with 28 years to maturity that is quoted at 106 percent of face value. The issue makes semiannual payments and has an embedded cost of 6 percent annually. What is the company's pretax cost of debt? multiple choice 1 5.57% 6.69% 4.24% 6.13% 5.02% If the tax rate is 24 percent, what is the aftertax cost of debt? multiple choice 2 4.24% 3.81% 4.66% 5.93% 5.57%arrow_forwardKose, Inc., has a target debt-equity ratio of 1.31. Its WACC is 8.1 percent, and the tax rate is 22 percent. a. If the company’s cost of equity is 12 percent, what is its pretax cost of debt? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) b. If instead you know that the aftertax cost of debt is 5.8 percent, what is the cost of equity? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)arrow_forward
- Blue Co. is funded only by debt and equity with a weighted average cost of capital at 20%. The debt ratio of the company is 20%. Using the discounted cash flow model, the cost of equity is determined at 10%. The applicable after-tax rate of the company is 80%. Determine the cost of debt before the application of the tax shield. (In percentage, put percentage sign)arrow_forwardBento, Inc., has a target debt-equity ratio of .65. Its cost of equity is 16 percent, and its cost of debt is 5 percent. If the tax rate is 23 percent, what is the company’s WACC? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) WACC:______%arrow_forwardFusion Packaging is financed with 55% equity and 45% debt. The required rate of return on its debt is 4.4% and 12% on its equity. If the tax rate is 25%, what is Fusion's weighted-average cost of capital? Enter your answer as a percentage rounded to 2 decimal places.arrow_forward
arrow_back_ios
SEE MORE QUESTIONS
arrow_forward_ios
Recommended textbooks for you
Financial AccountingAccountingISBN:9781337272124Author:Carl Warren, James M. Reeve, Jonathan DuchacPublisher:Cengage Learning
EBK CONTEMPORARY FINANCIAL MANAGEMENTFinanceISBN:9781337514835Author:MOYERPublisher:CENGAGE LEARNING - CONSIGNMENT
Financial AccountingAccountingISBN:9781305088436Author:Carl Warren, Jim Reeve, Jonathan DuchacPublisher:Cengage Learning
Financial Accounting
Accounting
ISBN:9781337272124
Author:Carl Warren, James M. Reeve, Jonathan Duchac
Publisher:Cengage Learning
EBK CONTEMPORARY FINANCIAL MANAGEMENT
Finance
ISBN:9781337514835
Author:MOYER
Publisher:CENGAGE LEARNING - CONSIGNMENT
Financial Accounting
Accounting
ISBN:9781305088436
Author:Carl Warren, Jim Reeve, Jonathan Duchac
Publisher:Cengage Learning
Financial leverage explained; Author: The Finance story teller;https://www.youtube.com/watch?v=GESzfA9odgE;License: Standard YouTube License, CC-BY