Loose Leaf for Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
11th Edition
ISBN: 9781259709685
Author: Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe
Publisher: McGraw-Hill Education
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Textbook Question
Chapter 17, Problem 9QP
Personal Taxes, Bankruptcy Costs, and Firm Value When personal taxes on interest income and bankruptcy costs are considered, the general expression for the value of a levered firm in a world in which the tax rate on equity distributions equals zero is:
VL = Vu + {1–[(1 – tc)/(1 – tB)]}×B – C(B)
where:
VL = The value of a levered firm.
Vu = The value of an unlevered firm.
B = The value of the firm’s debt.
tc = The tax rate on corporate income.
tB= The personal tax rate on interest income.
C(B) = The present value of the costs of financial distress.
- a. In their no-tax model, what do Modigliani and Miller assume about tc tB, and C(B)? What do these assumptions imply about a firm’s optimal debt-equity ratio?
- b. In their model with corporate taxes, what do Modigliani and Miller assume about tc, tB, and C(B)? What do these assumptions imply about a firm’s optimal debt- equity ratio?
- c. Consider an all-equity firm that is certain to be able to use interest deductions to reduce its corporate tax bill. If the corporate tax rate is 34 percent the personal tax rate on interest income is 20 percent, and there are no costs of financial distress, by how much will the value of the firm change if it issues $1 million in debt and uses the proceeds to repurchase equity’?
- d. Consider another all-equity firm that does not pay taxes due to large tax loss earryforwards from previous years. The personal tax rate on interest income is 20 percent, and there are no costs of financial distress. What would be the change in the value of this firm from adding $1 of perpetual debt rather than $1 of equity?
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Assuming that there is an unlevered firm and a levered firm. The basic information is given by the following table.
Table1: Information of the firms
Unlevered firm
Levered firm
EBIT
10000
10000
Interest
0
3200
Taxable income
Tax (tax rate: 34%)
Net income
CFFA
Assuming that cost of debt =8%; unlevered cost of capital =10%; systematic risk of the asset is 1.5
Fill in the blanks
What is the present value of the tax shield?
What is the size of debt?
Calculate the following values:a) value of unlevered firm; b) value of the levered firm; c) equity value; d) Cost of equity; e) cost of capital; f) systematic risk of the equity
Suppose that the firm changes its capital structure so that the debt-to-equity ratio is 1.0, then recalculate the systematic risk of the equity
Based on the results of question (4), if there are the following two mutually exclusive projects. What is the crossover required rate of return…
Given the following information, how much value will leverage will add to, or subtract from, the firm if the firm were to add one additional pound of debt?
Corporate tax = 15%
Personal tax on debt = 30%
Personal tax on equity = 10%
Select one:
-0.09
0.00
0.30
0.55
None of the above
Please show your work for the following
Suppose that your firm's current unlevered value, V*, is $800,000, and its marginal corporate tax rate is 21 percent. Also, you model the firm's PV of financial distress as a function of its debt level according to the relation: PV of financial distress = 800,000 × (D/V*)2. What is the firm's levered value if it issues $200,000 of perpetual debt to buy back stock?
Multiple Choice
A) $920,000.
B) $869,555.
C) $792,000.
D) $350,000.
Chapter 17 Solutions
Loose Leaf for Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
Ch. 17 - Bankruptcy Costs What are the direct and indirect...Ch. 17 - Stockholder Incentives Do you agree or disagree...Ch. 17 - Capital Structure Decisions Due to large losses...Ch. 17 - Cost of Debt What steps can stockholders take to...Ch. 17 - MM and Bankruptcy Costs How does the existence of...Ch. 17 - Agency Costs of Equity What are the sources of...Ch. 17 - Observed Capital Structures Refer to the observed...Ch. 17 - Bankruptcy and Corporate Ethics As mentioned in...Ch. 17 - Bankruptcy and Corporate Ethics Finns sometimes...Ch. 17 - Prob. 10CQ
Ch. 17 - Firm Value Janetta Corp. has EBIT of 5850,000 per...Ch. 17 - Agency Costs Tom Scott is the owner, president and...Ch. 17 - Nonmarketed Claims Dream, Inc., has debt...Ch. 17 - Prob. 4QPCh. 17 - Capital Structure and Growth Edwards Construction...Ch. 17 - Prob. 6QPCh. 17 - Agency Costs Fountain Corporations economists...Ch. 17 - Financial Distress Good Time Company is a regional...Ch. 17 - Personal Taxes, Bankruptcy Costs, and Firm Value...Ch. 17 - Personal Taxes, Bankruptcy Costs, and Firm Value...Ch. 17 - What is the expected value of the company in one...Ch. 17 - Prob. 2MCCh. 17 - One year from now, how much value creation is...Ch. 17 - Prob. 4MCCh. 17 - Prob. 5MCCh. 17 - Prob. 6MC
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