PRIN.OF CORPORATE FINANCE
13th Edition
ISBN: 9781260013900
Author: BREALEY
Publisher: RENT MCG
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Textbook Question
Chapter 18, Problem 4PS
Tax shields Look back at the Johnson & Johnson example in Section 18-1. Suppose Johnson & Johnson increases its long-term debt to $45 billion. It uses the additional debt to repurchase shares. Reconstruct Table 18.4B with the new capital structure. How much additional value is added for Johnson & Johnson shareholders if the table’s assumptions are correct?
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Suppose that Tap Dance, Incorporated's capital structure features 60 percent equity, 40 percent debt, and that its before-tax cost of debt is 7 percent, while its cost of equity is 12 percent. The appropriate weighted average tax rate is 21 percent and TapDance estimates it cannot make any use of the interest tax shield in the foreseeable future. What will be TapDance's WACC? Note: Round your answer to 2 decimal places.
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…
An overview of a firm's cost of debt
For which capital component must you make a tax adjustment when calculating a firm’s weighted average cost of capital (WACC)? Pick the correct choice.
A- Preferred stock
B- Equity
C- Debt
Three Waters Company (TWC) can borrow funds at an interest rate of 12.50% for a period of five years. Its marginal federal-plus-state tax rate is 45%. TWC’s after-tax cost of debt is_________% (rounded to two decimal places).
At the present time, Three Waters Company (TWC) has 15-year noncallable bonds with a face value of $1,000 that are outstanding. These bonds have a current market price of $1,136.50 per bond, carry a coupon rate of 12%, and distribute annual coupon payments. The company incurs a federal-plus-state tax rate of 45%. If TWC wants to issue new debt, what would be a reasonable estimate for its after-tax cost of debt (rounded to two decimal places)? Pick the correct choice.
5.60%
5.04%…
Chapter 18 Solutions
PRIN.OF CORPORATE FINANCE
Ch. 18 - Prob. 1PSCh. 18 - Tax shields Compute the present value of interest...Ch. 18 - Tax shields Here are book and market value balance...Ch. 18 - Tax shields Look back at the Johnson Johnson...Ch. 18 - Prob. 5PSCh. 18 - Tax shields The firm cant use interest tax shields...Ch. 18 - Prob. 7PSCh. 18 - Tax shields The trouble with MMs argument is that...Ch. 18 - Bankruptcy costs On February 29, 2019, when PDQ...Ch. 18 - Financial distress This question tests your...
Ch. 18 - Prob. 12PSCh. 18 - Agency costs Let us go back to Circular Files...Ch. 18 - Agency costs The Salad Oil Storage (SOS) Company...Ch. 18 - Agency costs The possible payoffs from Ms....Ch. 18 - Prob. 17PSCh. 18 - Prob. 18PSCh. 18 - Prob. 20PSCh. 18 - Pecking-order theory Fill in the blanks: According...Ch. 18 - Financial slack For what kinds of companies is...Ch. 18 - Financial slack True or false? a. Financial slack...Ch. 18 - Debt ratios Rajan and Zingales identified four...Ch. 18 - Leverage targets Some corporations debtequity...Ch. 18 - Prob. 26PSCh. 18 - Trade-off theory The trade-off theory relies on...
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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
- WACC and Optimal Capital Structure F. Pierce Products Inc. is considering changing its capital structure. F. Pierce currently has no debt and no preferred stock, but it would like to add some debt to take advantage of low interest rates and the tax shield. Its investment banker has indicated that the pre-tax cost of debt under various possible capital structures would be as follows: F. Pierce uses the CAPM to estimate its cost of common equity, rs and at the time of the analysis the risk-free rate is 5%, the market risk premium is 6%, and the companys tax rate is 40%. F. Pierce estimates that its beta now (which is unlevered because it currently has no debt) is 0.8. Based on this information, what is the firms optimal capital structure, and what would be the weighted average cost of capital at the optimal capital structure?arrow_forwardAn all equity corporation has net income of $63,313and a required rate of return of 0.14%. What would the value of this firm be if it borrowed $141,848 to buy back some of its stock? Assume a corporate tax rate of 0.45%.arrow_forwardThe user cost of capital: Consider the basic formula for the user cost ofcapital in the presence of a corporate income tax. Suppose the baseline casefeatures an interest rate of 2 percent, a rate of depreciation of 6 percent, aprice of capital that rises at 1 percent per year, and a 0 percent corporate taxrate. Starting from this baseline case, what is the user cost of capital after thefollowing changes?(a) No changes—the baseline case.(b) Te corporate tax rate rises to 35 percent.(c) Te interest rate doubles to 4 percent.(d) Both (b) and (c).arrow_forward
- Suppose that MNINK Industries’ capital structure features 63 percent equity, 8 percent preferred stock, and 29 percent debt. Assume the before-tax component costs of equity, preferred stock, and debt are 11.60 percent, 9.50 percent, and 9.00 percent, respectively.What is MNINK’s WACC if the firm faces an average tax rate of 21 percent and can make full use of the interest tax shield? (Round your answer to 2 decimal places.) WACC: ____.__%arrow_forwardFor which capital component must you make a tax adjustment when calculating a firm’s weighted average cost of capital (WACC)? Equity Debt Preferred stock Water and Power Company (WPC) can borrow funds at an interest rate of 7.30% for a period of five years. Its marginal federal-plus-state tax rate is 25%. WPC’s after-tax cost of debt is (7.30, 5.21, 6.03, 5.48) (rounded to two decimal places). At the present time, Water and Power Company (WPC) has 15-year noncallable bonds with a face value of $1,000 that are outstanding. These bonds have a current market price of $1,136.50 per bond, carry a coupon rate of 12%, and distribute annual coupon payments. The company incurs a federal-plus-state tax rate of 25%. If WPC wants to issue new debt, what would be a reasonable estimate for its after-tax cost of debt (rounded to two decimal places)? (Note: Round your YTM rate to two decimal place.) 9.17% 8.79% 7.64% 6.11%arrow_forwardAssuming 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?arrow_forward
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