30. Trade-Off Theory. Smoke and Mirrors currently has EBIT of $25,000 and is all-equity- financed. EBIT is expected to stay at this level indefinitely. The firm pays corporate taxes equal to 21% of taxable income. The discount rate for the firm's projects is 10%. (LO16-3) a. What is the market value of the firm? b. Now assume the firm issues $50,000 of debt paying interest of 6% per year, using the proceeds to retire equity. The debt is expected to be permanent. What will happen to the total value of the firm (debt plus equity)? c. Recompute your answer to part (b) under the following assumptions: The debt issue raises the probability of bankruptcy. The firm has a 30% chance of going bankrupt after If it does go bankrupt, it will incur bankruptcy costs of $200,000. The discount 3 years. rate is 10%. d. Should the firm issue the debt under these new assumptions?

30. Trade-Off Theory. Smoke and Mirrors currently has EBIT of $25,000 and is all-equity- financed. EBIT is expected to stay at this level indefinitely. The firm pays corporate taxes equal to 21% of taxable income. The discount rate for the firm's projects is 10%. (LO16-3) a. What is the market value of the firm? b. Now assume the firm issues $50,000 of debt paying interest of 6% per year, using the proceeds to retire equity. The debt is expected to be permanent. What will happen to the total value of the firm (debt plus equity)? c. Recompute your answer to part (b) under the following assumptions: The debt issue raises the probability of bankruptcy. The firm has a 30% chance of going bankrupt after If it does go bankrupt, it will incur bankruptcy costs of $200,000. The discount 3 years. rate is 10%. d. Should the firm issue the debt under these new assumptions?

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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Ch. 13. For questions 7, 8, and 9, use the following information: 7.) Consider a firm whose debt has a market value of $35 million and whose stock has a market value of $55 million. The firm pays a 7 percent rate of interest on its new debt and has a beta of 1.23. The corporate tax rate is 21%. Assume that the security market line holds, that the risk premium on the market is 10.5 percent, and that the current Treasury bill is rate is 1 percent. What is the aftertax cost of debt? Format as a percentage and round to two places past the decimal point as "X.XX" 8.) Consider a firm whose debt has a market value of $35 million and whose stock has a market value of $55 million. The firm pays a 7 percent rate of interest on its new debt and has a beta of 1.23. The corporate tax rate is 21%. Assume that the security market line holds, that the risk premium on the market is 10.5 percent, and that the current Treasury bill is rate is 1 percent. Using the pretax cost of debt from Question 7,…
Adamson Corporation is considering four average-risk projects with the following costs and rates of return: Project 1 2 3 4 $2.000 Open spreadsheet Cost Cost of debt 3,000 5,000 2.000 Project 1 Project 2 Project 3 Project 4 Expected Rate of Return 16.00% The company estimates that it can issue debt at a rate of r = 9%, and its tax rate is 30%. It can issue preferred stock that pays a constant dividend of $5 per year at $44 per share. Also, common stock currently sells for $33 per share; the next expected dividend, D₂, is $4.00; and the dividend is expected to grow at a constant rate of 5% per year. The target capital structure consists of 75% common stock, 15% debt, and 10% preferred stock. The data has been collected in the Microsoft Excel Online e below. Open the spreadsheet and perform the required analysis to answer the questions below. % 15.00 a. What is the cost of each of the capital components? Round your answers to two decimal places. Do not round your intermediate…
Hw.16. Blue Angel, Inc., a private firm in the holiday gift industry, is considering a new project. The company currently has a target debt–equity ratio of .45, but the industry target debt–equity ratio is .40. The industry average beta is 1.30. The market risk premium is 8 percent, and the risk-free rate is 6 percent. Assume all companies in this industry can issue debt at the risk-free rate. The corporate tax rate is 35 percent. The project requires an initial outlay of $676,000 and is expected to result in a $96,000 cash inflow at the end of the first year. The project will be financed at the company’s target debt–equity ratio. Annual cash flows from the project will grow at a constant rate of 6 percent until the end of the fifth year and remain constant forever thereafter. Calculate the NPV of the project.
MM Model with Zero Taxes An unlevered firm has a value of $575 million. An otherwise identical but levered firm has $200 million in debt. Under the MM zero-tax model, what is the value of the levered firm? Enter your answer in millions. For example, an answer of $10,550,000 should be entered as 10.55. Round your answer to the nearest whole number. million
Pls help correctly, I only need c part and correct with approach and explanation.
Stevensons bakeries and all equity firm that has a projected perpetual EBIT of $144,000 per year. The cost of equity is 10.5% and the tax rate is 21%. Assume there's no depreciation, no capital spending and no change in networking capital. The firm can borrow perpetual debt at 5.8%. Currently, the firm is considering converting to a debt equity ratio of .54. What is the firms levered value? MM assumptions hold.
Consider a project of the Cornell Haul Moving Company, the timing and size of the incremental after-tax cash flows (for an all-equity firm) are shown below in millions: Time Cash Flow -$ 990 125 250 375 500 The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent; the current and target debt-equity ratio is 2; if the firm were financed entirely with equity, the required return would be 10 percent. What is the levered after-tax incremental cash flow for year 2? 0000 2 3 4 $185,796,000 $215,152,000 $284,848,000 $267,952,000
You are comparing two possible capital structures for a firm. The first option is an all-equity firm. The second option involves the use of $3.8 million of debt. The break-even point between these two financing options occurs when earnings before interest and taxes (EBIT) are $428,000. Given this, you know that leverage is beneficial to the firm: A- whenever EBIT exceeds $428,000 B- whenever EBIT is less than $428,000 C- only when EBIT is $428,000 D- only if the debt is decreased by $428,000 E- only is the debt is increased by $428,000
A company is considering its optimal capital structure. The firm currently has 1 million shares outstanding at $ 20 per share (tax rate = 40%) and a debt balance of $5 million. Currently, its (levered) beta is 1.5 and its ERP is 5.5%. The current risk-free rate is 5%. Your research indicate the following ratings and pre-tax cost of debt across the different debt ratios: D/(D+E) Rating Pre-tax cost of debt 0% AAA 10% 10% AA 10.5% 20% A 11% 30% BBB 12% 40% BB 13% 50% B 14% 60% CCC 16% 70% CC 18% 80% C 20% 90% D 25% a. Using the optimal WACC approach, what is the firm's optimal debt ratio? b. Calculate the company's unlevered value, assuming that the probability of default is 5% and the company loses 30% of its value in the event of a default.
Please solve the below with detailed explanation
MM Model with Zero Taxes An unlevered firm has a value of $625 million. An otherwise identical but levered firm has $75 million in debt. Under the MM zero-tax model, what is the value of the levered firm? Enter your answer in millions. For example, an answer of $10,550,000 should be entered as 10.55. Round your answer to the nearest whole number. LA million
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