EBK CORPORATE FINANCE
4th Edition
ISBN: 8220103164535
Author: DeMarzo
Publisher: PEARSON
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Chapter 15, Problem 27P
PMF, Inc., is equally likely to have EBIT this coming year of $10 million, $15 million, or $20 million. Its corporate tax rate is 35%, and investors pay a 15% tax rate on income from equity and a 35% tax rate on interest income.
- a. What is the effective tax advantage of debt if PMF has interest expenses of $8 million this coming year?
- b. What is the effective tax advantage of debt for interest expenses in excess of $20 million? (Ignore carryforwards.)
- c. What is the expected effective tax advantage of debt for interest expenses between $10 million and $15 million? (Ignore carryforwards.)
- d. What level of interest expense provides PMF with the greatest tax benefit?
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Assume that CVC Corp.'s marginal tax rate is 35%, investors in CVC pay a 15% tax rate on income from equity and a 35% tax rate on interest income. CVC is equally likely to have EBIT this coming year of $20 million, $25 million, or $30 million. What is the effective tax advantage of debt if CVC has interest expenses of $8 million this coming year?
2. An overview of a firm's cost of debt
To calculate the after-tax cost of debt, multiply the before-tax cost of debt by (1-T).
Western Gas & Electric Company (WGC) can borrow funds at an interest rate of 11.10% for a period of six years. Its marginal federal-plus-state tax
rate is 25%. WGC's after-tax cost of debt is 8.32% (rounded to two decimal places).
At the present time, Western Gas & Electric Company (WGC) has 10-year noncallable bonds with a face value of $1,000 that are outstanding. These
bonds have a current market price of $1,495.56 per bond, carry a coupon rate of 10%, and distribute annual coupon payments. The company incurs a
federal-plus-state tax rate of 25%. If WGC 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.)
2.94%
2.35%
2.65%
3.38%
Suppose a firm's tax rate is 25%.
a. What effect would a $9.05 million operating expense have on this year's earnings? What effect would it have on
next year's earnings?
b. What effect would a $10.2 million capital expense have on this year's earnings if the capital expenditure is
depreciated at a rate of $2.04 million per year for five years? What effect would it have on next year's earnings?
a. What effect would a $9.05 million operating expense have on this year's earnings? What effect would it have on
next year's earnings? (Select all the choices that apply.)
A. A $9.05 million operating expense would be immediately expensed, increasing operating expenses by $9.05
million. This would lead to a reduction in taxes of 25% x $9.05 million = $2.26 million.
B. A $9.05 million operating expense would be immediately expensed, increasing operating expenses by $9.05
million. This would lead to an increase in taxes of 25% × $9.05 million = $2.26 million.
C. Earnings would decline by $9.05…
Chapter 15 Solutions
EBK CORPORATE FINANCE
Ch. 15.1 - With corporate income taxes, explain why a firms...Ch. 15.1 - Prob. 2CCCh. 15.2 - With corporate taxes as the only market...Ch. 15.2 - How does leverage affect a firms weighted average...Ch. 15.3 - How can shareholders benefit from a leveraged...Ch. 15.3 - How does the interest tax shield enter into the...Ch. 15.4 - Prob. 1CCCh. 15.4 - How does this personal tax disadvantage of debt...Ch. 15.5 - How does the growth rate of a firm affect the...Ch. 15.5 - Do firms choose capital structures that fully...
Ch. 15 - Prob. 1PCh. 15 - Grommit Engineering expects to have net income...Ch. 15 - Suppose the corporate tax rate is 40%. Consider a...Ch. 15 - Braxton Enterprises currently has debt outstanding...Ch. 15 - Your firm currently has 100 million in debt...Ch. 15 - Arnell Industries has just issued 10 million in...Ch. 15 - Prob. 7PCh. 15 - Prob. 8PCh. 15 - Safeco Inc. has no debt, and maintains a policy of...Ch. 15 - Rogot Instruments makes fine violins and cellos....Ch. 15 - Rumolt Motors has 30 million shares outstanding...Ch. 15 - Summit Builders has a market debt-equity ratio of...Ch. 15 - NatNah, a builder of acoustic accessories, has no...Ch. 15 - Restex maintains a debt-equity ratio of 0.85, and...Ch. 15 - Acme Storage has a market capitalization of 100...Ch. 15 - Milton Industries expects free cash flow of 5...Ch. 15 - Prob. 17PCh. 15 - Kurz Manufacturing is currently an all-equity firm...Ch. 15 - Rally, Inc., is an all-equity firm with assets...Ch. 15 - Prob. 20PCh. 15 - Facebook, Inc. had no debt on its balance sheet in...Ch. 15 - Markum Enterprises is considering permanently...Ch. 15 - Garnet Corporation is considering issuing...Ch. 15 - Suppose the tax rate on interest income is 35%,...Ch. 15 - With its current leverage, Impi Corporation will...Ch. 15 - Colt Systems will have EBIT this coming year of 15...Ch. 15 - PMF, Inc., is equally likely to have EBIT this...
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- Consider two firms, Go Debt corporation and No Debt corporation. Both firms are expected to have earnings before interest and taxes of $100,000 during the coming year. In addition, Go Debt is expected to incur $40,000 in interest expenses as a result of its borrowings whereas No Debt will incur no interest expense because it does not use debt financing. Both firms are in the 21 percent tax bracket. Calculate the earnings after tax for both firms. Compare the difference in after-tax earnings to the difference in interest expense. Can you reconcile that difference?arrow_forwardWilmore Company Limited is a levered entity with percentage of debt out of total capital being 40%. If the interest rate on a bank loan is 10%, the tax rate is 20%, and the cost of equity is as computed in (a), what will be the after tax cost of debt?arrow_forwardICU Window, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 9 years to maturity that is quoted at 107 percent of face value. The issue makes semiannual payments and has an embedded cost of 6.6 percent annually. What is the company's pretax cost of debt? If the tax rate is 24 percent, what is the aftertax cost of debt? Pretax cost of debt: __________% Aftertax cost of debt: __________%arrow_forward
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- For which capital component must you make a tax adjustment when calculating a firm's weighted average cost of capital (WACC)? O Debt O Equity O Preferred stock Western Gas & Electric Company (WGC) can borrow funds at an interest rate of 9.70% for a period of four years. Its marginal federal-plus-state tax rate is 40%. WGC's after-tax cost of debt is (rounded to two decimal places). At the present time, Western Gas & Electric Company (WGC) has 5-year noncallable bonds with a face value of $1,000 that are outstanding. These bonds have a current market price of $1,229.24 per bond, carry a coupon rate of 10%, and distribute annual coupon payments. The company incurs a federal-plus-state tax rate of 40%. If WGC 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.) O 2.84% 2.56% O 3.41% 3.27%arrow_forwardA company has interest expenses totaling = $722 MM, for which they pay 7%/annum to their lender. Last year, the company paid $827 MM in tax, based on earnings before taxes of $4, 135M; what amount of additional taxes would the co. pay if they were all equity - financed (i.e., no debt) and what is the PV of tax shield (assume all metrics stay constant in perpetuity)?arrow_forward2arrow_forward
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