Mindtap For Brigham/ehrhardt's Financial Management: Theory & Practice, 1 Term Printed Access Card (mindtap Course List)
16th Edition
ISBN: 9781337909655
Author: Eugene F. Brigham, Michael C. Ehrhardt
Publisher: Cengage Learning
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Chapter 21, Problem 2MC
1.
Summary Introduction
Case summary: The Person DL is the CEO of the Company LST has debt financing concerns. The Company LST uses temporary debt rather than permanent or long-term debt. The person wonders the reason of using debt sources for financing and its impact on the value of stocks. Due to this, the person raised some question to the assistant which was hired recently.
To determine: The value of V, s, r and WACC for firm U and L.
b.
Summary Introduction
To draw: A graph showing relationship between capital cost and leverage and also relationship between value of the firm and debt.
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Assume that Firms U and L are in the same risk class and that both have EBIT=$500,000. Firm U uses no debt financing, and its cost of equity is rsU=14%. Firm L has $1 million of debt outstanding at a cost of rd=8%. There are no taxes. Assume that the MM assumptions hold.
Find V, S, rs, and WACC for Firms U
Firms A and B are identical except for their capital structure. A carries no debt, whereas B carries £50m of debt on which it pays a 5% interest rate. Assume no taxes and perfect capital markets where investors and firms can lend and borrow at the same risk free rate. Some of the relevant numbers are provided in the following table (in £ m):
A. In the absence of arbitrage opportunities, the value of B is £100m
B. In the absence of arbitrage opportunities, B’s weighted average cost of capital is 10%
C. In the absence of arbitrage opportunities, B’s return on equity is 15%
D. In the absence of arbitrage opportunities, B’s return on equity is higher than A’s return on equity.
Assume that Firms U and L are in the same risk class and that both have EBIT=$500,000. Firm U uses no debt financing, and its cost of equity is rsU=14%. Firm L has $1 million of debt outstanding at a cost of rd=8%. There are no taxes. Assume that the MM assumptions hold.
Graph (a) the relationships between capital costs and leverage as measured by D/V and (b) the relationship between V and D.
Now assume that Firms L and U are both subject to a 40% corporate tax rate. Using the data given in Part b, repeat the analysis called for in b(1) and b(2) using assumptions from the MM model with taxes.
Chapter 21 Solutions
Mindtap For Brigham/ehrhardt's Financial Management: Theory & Practice, 1 Term Printed Access Card (mindtap Course List)
Ch. 21 - Prob. 1QCh. 21 - Modigliani and Miller assumed that firms do not...Ch. 21 -
An unlevered firm has a value of $500 million. An...Ch. 21 -
An unlevered firm has a value of $500 million. An...Ch. 21 - Prob. 3PCh. 21 - Prob. 4PCh. 21 - A company’s most recent free cash flow to equity...Ch. 21 - Air Tampa has just been incorporated, and its...Ch. 21 - Companies U and L are identical in every respect...Ch. 21 - Schwarzentraub Corporation’s expected free cash...
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