Fundamentals of Corporate Finance
11th Edition
ISBN: 9781259870576
Author: Ross
Publisher: MCG
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Chapter 17, Problem 13QP
Expected Return, Dividends, and Taxes [LO2] The Gecko Company and the Gordon Company are two firms whose business risk is the same but that have different dividend policies. Gecko pays no dividend, whereas Gordon has an expected dividend yield of 3.5 percent. Suppose the
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Question 14
General Electric expects a net income next year of $19.53 million, and a free cash flow of $22.47 million. The company has a marginal corporate tax rate of 35%.
Suppose General Electric increases its leverage, such that the interest expense of the company rises by $2.6 million. How will net income change? Show your work.
2. For the same increase in interest expense in part (1), how will free cash flow change?
Free cash flow will increase by $2.6 million.
Free cash flow will increase by less than $2.6 million.
Free cash flow will remain the same.
Free cash flow will decrease by less than $2.6 million
Free cash flow will decrease by $2.6 million
p5
In a world with taxes, the value of a leveraged firm equals the value of an unleveraged firm plus:
the present value of its debt.
the present value of the interest tax shield.
the present value of its future cash flows.
none of the above.
Question 3Nelco Inc. has decided in favour of a capital structuring that involves increasing its existing $80 million in debt to $125 million. The interest rate on debt is 9% and is not expected to change. The firm currently has 10 million shares outstanding and the price per share is $45. If the restructuring is expected to increase the ROE, what is the minimum level of EBIT that Nelco’s management must be expecting. Ignore taxes in your answer.
Chapter 17 Solutions
Fundamentals of Corporate Finance
Ch. 17.1 - Prob. 17.1ACQCh. 17.1 - What are the mechanics of the cash dividend...Ch. 17.1 - How should the price of a stock change when it...Ch. 17.2 - How can an investor create a homemade dividend?Ch. 17.2 - Prob. 17.2BCQCh. 17.3 - Prob. 17.3ACQCh. 17.3 - Why do flotation costs favor a low payout?Ch. 17.4 - Why might some individual investors favor a high...Ch. 17.4 - Prob. 17.4BCQCh. 17.5 - How does the market react to unexpected dividend...
Ch. 17.5 - Prob. 17.5BCQCh. 17.6 - Prob. 17.6ACQCh. 17.6 - Prob. 17.6BCQCh. 17.8 - Prob. 17.8ACQCh. 17.8 - How does the accounting treatment of a stock split...Ch. 17 - Dividends are paid to the parties listed as...Ch. 17 - Prob. 17.3CTFCh. 17 - Prob. 17.4CTFCh. 17 - Prob. 17.8CTFCh. 17 - Dividend Policy Irrelevance [LO2] How is it...Ch. 17 - Prob. 2CRCTCh. 17 - Prob. 3CRCTCh. 17 - Prob. 4CRCTCh. 17 - Prob. 5CRCTCh. 17 - Prob. 6CRCTCh. 17 - Prob. 7CRCTCh. 17 - Prob. 8CRCTCh. 17 - Prob. 9CRCTCh. 17 - Prob. 10CRCTCh. 17 - Prob. 1QPCh. 17 - Prob. 2QPCh. 17 - Prob. 3QPCh. 17 - Prob. 4QPCh. 17 - Regular Dividends [LO1] The balance sheet for...Ch. 17 - Prob. 6QPCh. 17 - Prob. 7QPCh. 17 - Stock Dividends [LO3] The company with the common...Ch. 17 - Stock Splits [LO3] In the previous problem,...Ch. 17 - Homemade Dividends [LO2] You own 1,000 shares of...Ch. 17 - Prob. 11QPCh. 17 - Stock Repurchase [LO4] Galles Corporation is...Ch. 17 - Expected Return, Dividends, and Taxes [LO2] The...Ch. 17 - Dividends and Taxes [LO2] As discussed in the...Ch. 17 - Prob. 15QPCh. 17 - Dividends versus Reinvestment [LO2] After...Ch. 17 - Prob. 1MCh. 17 - Prob. 2MCh. 17 - Prob. 3MCh. 17 - Prob. 4MCh. 17 - Prob. 5MCh. 17 - Prob. 6M
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- Q. 6 High Flyer, Inc., wishes to maintain a growth rate of 14% per year and a debt-equity ratio of 0.5. The profit margin is 4.6%, and total asset turnover is constant at 1.16. What is the dividend payout ratio? (A negative answer should be indicated by a minus sign. DO NOT round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16) What is the maximum sustainable growth rate for this company? (DO NOT round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16)arrow_forward1a. Consider the statement that an asset with higher risk must earn higher risk premium. Is it true or false? Please explain. b) A company with growth opportunities has dividend growth every year. Do you agree or not? Please explain. c) The Trump administration lowered corporate tax rate and this is a monetary policy. Is it true or false? If false, what type of policy is it.arrow_forward59) During the coming year, Gold & Gold wants to increase its free cash flow by $180 million, which should result in a higher stock price. The CFO has made these projections for the upcoming year: ∙ EBIT is projected to equal $852 million. ∙ Gross capital expenditures are expected to total to $360 million versus depreciation of $120 million, so its net capital expenditures should total $240 million. ∙ The tax rate is 25%. ∙ There will be no changes in cash or marketable securities, nor will there be any changes in notes payable or accruals. What increase in net working capital (in millions of dollars) would enable the firm to meet its target increase in FCF? a. $379 b. $219 c. $263 d. $316 e. $175 63) If D 1 = $1.50, g (which is constant) = 6.5%, and P 0 = $56, what is the stock's expected capital gains yield for the coming year? a. 6.50% b. 7.52% c. 7.90% d. 7.17% e. 6.83% 64) Shulman…arrow_forward
- F2 You are analyzing a valuation done on a stable firm by a well-known analyst. Based on the expected free cash flow to firm next year of $30 million and an expected growth rate of 5%, the analyst has estimated a value of $750 million. You know that the firm has a cost of equity of 14% and an after-tax cost of debt of 6%. What is the weight of equity that the analyst has used? 37.5 % 42.5 % 50 % 57.5 % ANSWER IS 37.5%arrow_forward4. Assume the marginal corporate tax rate is 21 percent. The firm has no debt in its capital structure. It is valued at $100 million. What would be the value of the firm if it issued $50 million in perpetual debt and repurchased the same amount of equity?arrow_forwardwhich one is correct please confirm? QUESTION 20 Kermit's Hardware's (KH) fixed operating costs are $20.8 million, and its variable cost ratio is 0.30. The firm has $10 million in bonds outstanding with a coupon interest rate of 9%. KH has 200,000 shares of common stock outstanding. The firm has revenues of $32.2 million, and its marginal tax rate is 40%. Compute KH's degree of financial leverage. a. 1.22 b. 1.09 c. 2.07 d. 1.04arrow_forward
- 5. Answer all questions: a) Increasing financial leverage can increase both the cost of debt and the cost of equity. How can the overall cost of capital stay unchanged in this situation? Assume there is no income tax paid by the firm. b) In (a) above, why should the value of the firm remain unchanged when the capital structure changes? Explain carefully. c) A share of stock with a beta of .75 now sells for $50. The investors expect the stock to pay a year-end dividend of $2. The Treasury bill rate is 4%, and the market risk premium is 7%. If the stock price is perceived to be fair today, what must be the investors’ expectation for the price of the stock at the end of the year? [Hint: at what rate should the stock price change annually?] d) XYZ borrows $800 million at an interest rate of 7.6%. Prior to this borrowing, it was an all-equity firm. It expects to maintain this debt level indefinitely. XYZ pays taxes at an effective rate of 37%. By how is the market value of…arrow_forward5 Dye Industries currently uses no debt, but its new CFO is considering changing the capital structure to 40.0% debt (wd) by issuing bonds and using the proceeds to repurchase and retire common shares so the percentage of common equity in the capital structure (wc) = 1 – wd. Given the data shown below, by how much would this recapitalization change the firm's cost of equity, i.e., what is rL - rU?Risk-free rate, rRF 6.00% Tax rate, T 30%Market risk premium, RPM 4.00% Current wd 0%Current beta, bU 1.15 Target wd 40% Group of answer choices 1.66% 2.15% 2.23% 2.02% 2.45% 1.84%arrow_forwardSubject: Financial strategy & policy Question No 3 (part i) Answer the following. i) The future earnings, dividends, and common stock price of Nabeel Inc. are expected to grow 7% per year. Common stock currently sells for $23.00 per share; its last dividend was $2.00. a) Using the DCF approach, what is its cost of common equity? b) If the firm’s beta is 1.6, the risk-free rate is 9%, and the average return on the market is 13%, what will be the firm’s cost of common equity using the CAPM approach? c) If the firm’s bonds earn a return of 12%, based on the bond-yield-plus-risk-premium approach, what will be rs? d) If you have equal confidence in the inputs used for the three approaches, what is your estimate of cost of common equity?arrow_forward
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Financial leverage explained; Author: The Finance story teller;https://www.youtube.com/watch?v=GESzfA9odgE;License: Standard YouTube License, CC-BY