CORPORATE FINANCE CUSTOM W/CONNECT >BI
11th Edition
ISBN: 9781307036633
Author: Ross
Publisher: MCG/CREATE
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Textbook Question
Chapter 16, Problem 20QP
MM Proposition I without Taxes Alpha Corporation and Beta Corporation are identical in every way except their capital structures. Alpha Corporation, an all-equity firm, has 18,000 shares of stock outstanding, currently worth $35 per share. Beta Corporation uses leverage in its capital structure. The market value of Beta’s debt is $85,000, and its cost of debt is 9 percent. Each firm is expected to have earnings before interest of $93,000 in perpetuity. Neither firm pays taxes. Assume that every investor can borrow at 9 percent per year.
- a. What is the value of Alpha Corporation?
- b. What is the value of Beta Corporation?
- c. What is the market value of Beta Corporation’s equity?
- d. How much will it cost to purchase 20 percent of each firm’s equity?
- e. Assuming each firm meets its earnings estimates, what will be the dollar return to each position in part (d) over the next year?
- f. Construct an investment strategy in which an investor purchases 20 percent of Alpha’s equity and replicates both the cost and dollar return of purchasing 20 percent of Beta’s equity.
- g. Is Alpha's equity more or less risky than Beta's equity? Explain.
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In-Class Example : MM Proposition I without Corporate Taxes
Alpha Corporation and Beta Corporation are identical in every way except their capital structures. Alpha Corporation, an all-equity firm, has 18,000 shares of stock outstanding, currently worth $35 per share. Beta Corporation uses leverage in its capital structure. The market value of Beta’s debt is $85,000, and its cost of debt is 9 percent. Each firm is expected to have earnings before interest and tax of $93,000 in perpetuity. Neither firm pays taxes. Assume that every investor can borrow at 9 percent per year, and no market frictions exist (perfect capital markets).
What is the value of Alpha Corporation?
What is the value of Beta Corporation?
What is the market value of Beta Corporation’s equity?
How much will it cost to purchase 20 percent of each firm’s equity?
Assuming each firm meets its earnings estimates, what will be the dollar return to each position in part (d) over the next year?…
Question 7
Gioanni Inc., has GH¢1 million in earnings before interest and taxes. Currently it is all-equity-financed. It may issue GH¢3 million in perpetual debt at 15 percent interest in order to repurchase stock, thereby recapitalizing the corporation. There are no personal taxes.
If the corporate tax rate is 40 percent, what is the income available to all security holders if the company remains all-equity-financed? If it is recapitalized?
What is the present value of the debt tax-shield benefits?
The equity capitalization rate for the company’s common stock is 20 percent while it remains all-equity-financed. What is the value of the firm if it remains all-equity financed? What is the firm’s value if it is recapitalized?
Chapter 9 #3 Assume that a firm has earned before-tax income. The corporate tax rate is 35 percent.
If the security used to finance the investment is $1,000 of 10 percent debt, the firm holding the debt (supplying the debt capital) will earn _______________after tax.
If the security used to finance the investment is $1,000 of 10 percent preferred stock, the corporation holding the preferred stock (supplying the capital) will earn _______________ after tax with a 0.70 dividend received reduction.
If the security used to finance the investment is $1,000 of common stock and if the entire after-tax amount of income is paid as a dividend, the corporation holding the common stock will earn _______________ after tax. The firm has earned before tax income of $153.85.
Chapter 16 Solutions
CORPORATE FINANCE CUSTOM W/CONNECT >BI
Ch. 16 - MM Assumptions List the three assumptions that lie...Ch. 16 - Prob. 2CQCh. 16 - Prob. 3CQCh. 16 - MM Propositions What is the quirk in the tax code...Ch. 16 - Prob. 5CQCh. 16 - Prob. 6CQCh. 16 - Optimal Capital Structure Is there an easily...Ch. 16 - Financial Leverage Why is the use of debt...Ch. 16 - Homemade Leverage What is homemade leverage?Ch. 16 - Capital Structure Goal What is the basic goal of...
Ch. 16 - Prob. 1QPCh. 16 - EBIT, Taxes, and Leverage Repeat p arts (a) and...Ch. 16 - ROE and Leverage Suppose the company in Problem 1...Ch. 16 - Break-Even EBIT Franklin Corporation is comparing...Ch. 16 - Prob. 5QPCh. 16 - Break-Even EBIT and Leverage Kolby Corp. is...Ch. 16 - Leverage and Stock Value Ignoring taxes in Problem...Ch. 16 - Homemade Leverage Star, Inc., a prominent consumer...Ch. 16 - Homemade Leverage and WACC ABC Co. and XYZ Co. are...Ch. 16 - MM Scarlett Corp. uses no debt. The weighted...Ch. 16 - Prob. 11QPCh. 16 - Calculating WACC Weston Industries has a...Ch. 16 - Prob. 13QPCh. 16 - MM and Taxes Bruce Co. expects its EBIT to be...Ch. 16 - MM and Taxes In Problem 14, what is the cost of...Ch. 16 - MM Proposition I Levered, Inc., and Unlevered,...Ch. 16 - MM Tool Manufacturing bas an expected EBIT of...Ch. 16 - Firm Value Cavo Corporation expects an EBIT of...Ch. 16 - MM Proposition I with Taxes The Dart Company is...Ch. 16 - MM Proposition I without Taxes Alpha Corporation...Ch. 16 - Cost of Capital Acetate, Inc., has equity with a...Ch. 16 - Homemade Leverage The Veblen Company and the...Ch. 16 - MM Propositions Locomotive Corporation is planning...Ch. 16 - Stock Value and Leverage Green Manufacturing,...Ch. 16 - Prob. 25QPCh. 16 - Prob. 26QPCh. 16 - Prob. 27QPCh. 16 - Prob. 28QPCh. 16 - Prob. 29QPCh. 16 - Prob. 30QPCh. 16 - STEPHENSON REAL ESTATE RECAPITALIZATION Stephenson...Ch. 16 - Prob. 2MCCh. 16 - Prob. 3MCCh. 16 - Prob. 4MCCh. 16 - Prob. 5MC
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