Sunshine Travel has earnings of £18 million of which £6 million is available for either investment or shareholders.Sunshine Travel has two options: a) it can invest the £6 million in Treasury bonds at 5 per cent or distribute as adividend. Sunshine Travel faces a corporate tax rate of 25 per cent. As managers of the firm, you know that theshareholder base is diverse. You have pension funds that are tax-exempt, corporate investors with a marginal taxrate of 25 per cent, and retail investors who have a 45 per cent marginal tax rate.Required:a) Consider the firm's investment decision from the perspective of pension funds, corporate investors, andretail investors. Discuss which decision is best for each group.b) Sunshine travel has decided to distribute the £6 million to shareholders. Advise Sunshine Travel thechoice between paying cash dividends and repurchasing shares.

The decision regarding investment is one that can be consider as the most important decision and…

Answered: Sunshine Travel has earnings of £18…

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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Check my work Consider a firm with an EBIT of $866,000. The firm finances its assets with $2,660,000 debt (costing 8 percent and is all tax deductible) and 560,000 shares of stock selling at $5.00 per share. To reduce the firm's risk associated with this financial leverage, the firm is considering reducing its debt by $1,000,000 by selling an additional 360,000 shares of stock. The firm's tax rate is 21 percent. The change in capital structure will have no effect on the operations of the firm. Thus, EBIT will remain at $866,000. Calculate the change in the firm's EPS from this change in capital structure. (Do not round intermediate calculations and round your final answers to 2 decimal places.) EPS before EPS after Difference
McConn Manufacturing is currently all-equity financed, has an EBIT of $2 million, and has a corporate tax rate of 21 percent. Natalie, the company’s founder, is the lone shareholder. All earnings are paid out as dividends to Natalie. If the firm were to convert $4 million of equity into debt, the cost would be 10 percent and Natalie would hold all the debt. Assume Natalie pays personal taxes on interest income at a rate of 37 percent but pays taxes on dividends at a rate of 20 percent. Calculate the total cash flow to Natalie after she pays personal taxes if the firm is unlevered and if it is levered
Sunshine Travel has earnings of £18 million of which £6 million is available for either investment or shareholders. Sunshine Travel has two options: a) it can invest the £6 million in Treasury bonds at 5 per cent or b)distribute as a dividend. Sunshine Travel faces a corporate tax rate of 25 per cent. As managers of the firm, you know that the shareholder base is diverse. You have pension funds that are tax-exempt, corporate investors with a marginal tax rate of 25 per cent, and retail investors who have a 45 per cent marginal tax rate. Required:b) Sunshine travel has decided to distribute the £6 million to shareholders. Advise Sunshine Travel the choice between paying cash dividends and repurchasing shares.
Hawar International is a shipping firm with a current share price of $4.50 and 10 million shares outstanding. Suppose Hawar announces plans to lower its corporate taxes by borrowing $10 million and repurchasing shares. a. With perfect capital markets, what will the share price be after this announcement? b. Suppose that Hawar pays a corporate tax rate of 40%, and that shareholders expect the change in debt to be permanent. If the only imperfection is corporate taxes, what will the share price be after this announcement? c. Suppose the only imperfections are corporate taxes and financial distress costs. If the share price rises to $4.55 after this announcement, what is the PV of financial distress costs Hawar will incur as the result of this new debt? Question content area bottom Part 1 a. With perfect capital markets, what will the share price be after this announcement? With perfect capital markets, the share price will be $enter your response here per share
The treasurer of Riley Coal Co. is asked to compute the cost of fixed income securities for her corporation. Even before making the calculations, she assumes the aftertax cost of debt is at least 3 percent less than that for preferred stock. Debt can be issued at a yield of 11.0 percent, and the corporate tax rate is 20 percent. Preferred stock will be priced at $60 and pay a dividend of $6.40. The flotation cost on the preferred stock is $6. a. Compute the aftertax cost of debt. (Do not round intermediate calculations. Input the answer as a percent rounded to 2 decimal places.) Compute the aftertax cost of preferred stock. (Do not round intermediate calculations. Input your answer as a percent rounded to 2 decimal places.) Based on the facts given above, is the treasurer correct?
Consider a firm with an EBITDA of $1,100,000 and an EBIT of $1,000,000. The firm finances its assets with $4,640,000 debt (costing 8.4 percent, all of which is tax deductible) and 214,000 shares of stock selling at $12 per share. To reduce risk associated with this financial leverage, the firm is considering reducing its debt by $2,640,000 by selling additional shares of stock. The firm’s tax rate is 21 percent. The change in capital structure will have no effect on the operations of the firm. Thus, EBIT will remain at $1,000,000. Calculate the EPS before and after the change in capital structure and indicate changes in EPS.
Consider a firm with an EBITDA of $1,100,000 and an EBIT of $1,000,000. The firm finances its assets with $4,650,000 debt (costing 8.6 percent, all of which is tax deductible) and 216,000 shares of stock selling at $18 per share. To reduce risk associated with this financial leverage, the firm is considering reducing its debt by $2,700,000 by selling additional shares of stock. The firm's tax rate is 21 percent. The change in capital structure will have no effect on the operations of the firm. Thus, EBIT will remain at $1,000,000. Calculate the EPS before and after the change in capital structure and indicate changes in EPS. (Do not round intermediate calculations. Round your answers to 2 decimal places.) EPS before EPS after Changes in debt $ $ $ 2:19 1.80 0:40
Cooley Corporation has $20,000 that it plans to invest in marketable securities. It is choosing between MCI bonds which yield 10 percent, state of Colorado municipal bonds which yield 7 percent, and MCI preferred stock with a dividend yield of 8 percent. Cooley's corporate tax rate is 40 percent, and 70 percent of its dividends received are tax exempt. What is the after-tax rate of return on the highest yielding security? A. a. 7.04% B. b. 7.0% C. c. 8.43% D. d. 6.9% E. e. 6.0%
Rally inc, is an all equity firm with assets worth $25B and 10B shares outstanding. Rally plans to borrow $10B and use funds to repurchase shares. Rally’s corporate tax rate is 35% and Rally plans to keep its outstanding debt equal to $10B permanently. Suppose Rally offers $3 per share, and shareholders tender their shares at this price. What will be Rally’s share price after the repurchase?
Corporations often distribute profits to their shareholders in the form of dividends, which are simply checks mailed out to shareholders. Suppose that you have the chance to buy a share in a fashion company called Rogue Designs for $35 and that the company will pay dividends of $2 per year on that share every year. What is the annual percentage rate of return? Next, suppose that you and other investors could get a 12 percent per year rate of return by owning the stocks of other very similar fashion companies. If investors care only about rates of return, what should happen to the share price of Rogue Designs? (Hint: This is an arbitrage situation.)
Guam Motors is presently an all equity firm. It needs to raise $2.5m in additional funds. After raising its funds, it expects perpetual EBIT to be $600,000. The firm's unlevered cost of equity is 12% and its before tax cost of debt is 8%. 1) If there are no corporate taxes, under M-M theory what is the value of Guam Motors if it employs common stock to raise the needed funds? 2)If there are no corporate taxes and Guam Motors employs debt to raise 50% of the firm value, what is the cost of equity, the weighted average cost of capital and the value of the firm? 3) If there are no corporate taxes and M-M theory holds, will investors prefer levered firm to the unlevered firm? Why? 4)Will the presence of corporate taxes increase or decrease the firm value? Why? 5)Assume that corporate tax is 25%. What is the all equity value of Guam Motors? 6)If the corporate tax is 25% and Guam Motors employees same amount of debt as in 2) to raise part of the firm value, what is the cost of equity,the…
In a Modigliani and Miller world with no taxes, a 100% equity financed company has generated £1m cash flows this year. Consider three alternative policies: 1) pay £1m to shareholders as dividends, 2) buy back £1m worth of shares, 3) retain all cash flows. Determine which of the following statements is correct. The company's value is higher under policy 1 The company's value is higher under policy 2 Shareholders are indifferent between all three policies Shareholders are indifferent between policy 1 and policy 2, but prefer both policies to policy 3

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