EBK CORPORATE FINANCE
4th Edition
ISBN: 8220103164535
Author: DeMarzo
Publisher: PEARSON
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Question
Chapter 16, Problem 19P
a)
Summary Introduction
To determine: The project agreed by the equity holder.
Introduction:
Equity is the total value of assets less than the total amount of all liabilities in a company.
Debt is a sum of money borrowed by a person from another. Debt is borrowed by companies and individuals to make a large purchase or to develop business. Debt is an amount that has to be repaid back at a later date, with interest.
b)
Summary Introduction
To determine: The cost of firm’s debt project
Introduction:
The effective tax rate is the normal tax assessment rate for a
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Use the following information to answer the question(s) below.
Nielson Motors has a debt-equity ratio of 1.8, an equity beta of 2, and a debt beta of 0.2. It is currently
evaluating the following projects, none of which would change Nielson's volatility.
Project 1
4
2 3
75 120 60
Investment 100
NPV 23
12
(All amounts are in $millions.)
5
80
18. 15 14
Nielson Motors should accept those projects with profitability indices greater than (2 decimal places):
Please see image to answer question.
The options for F are as follows;The firm should proceed with the recapitalization.The firm should not proceed with the recapitalization.
According to the M&M propositions, in a perfect market which of the following statements is true?
a.The value of the firm will be equal to the net present value of its underlying projects
b.The value of the firm is higher when financed with debt due to its lower cost
c.The net present value of a firmʹs projects should exceed the present value of the firmʹs issued claims
d.The net present value of a firmʹs projects will be higher if they are financed with debt since debt carries a lower cost
Chapter 16 Solutions
EBK CORPORATE FINANCE
Ch. 16.1 - Prob. 1CCCh. 16.1 - Does the risk of default reduce the value of the...Ch. 16.2 - If a firm files for bankruptcy under Chapter 11 of...Ch. 16.2 - Why are the losses of debt holders whose claims...Ch. 16.3 - Prob. 1CCCh. 16.3 - True or False: If bankruptcy costs are only...Ch. 16.4 - Prob. 1CCCh. 16.4 - According to the trade-off theory, all else being...Ch. 16.5 - Prob. 1CCCh. 16.5 - Why would debt holders desire covenants that...
Ch. 16.6 - Prob. 1CCCh. 16.6 - Prob. 2CCCh. 16.7 - Coca-Cola Enterprises is almost 50% debt financed...Ch. 16.7 - Why would a firm with excessive leverage not...Ch. 16.7 - Describe how management entrenchment can affect...Ch. 16.8 - How does asymmetric information explain the...Ch. 16.8 - Prob. 2CCCh. 16.9 - Prob. 1CCCh. 16.9 - Prob. 2CCCh. 16 - Gladstone Corporation is about to launch a new...Ch. 16 - Baruk Industries has no cash and a debt obligation...Ch. 16 - When a firm defaults on its debt, debt holders...Ch. 16 - Prob. 4PCh. 16 - Prob. 5PCh. 16 - Suppose Tefco Corp. has a value of 100 million if...Ch. 16 - You have received two job offers. Firm A offers to...Ch. 16 - As in Problem 1, Gladstone Corporation is about to...Ch. 16 - Kohwe Corporation plans to issue equity to raise...Ch. 16 - Prob. 10PCh. 16 - Prob. 11PCh. 16 - Hawar International is a shipping firm with a...Ch. 16 - Your firm is considering issuing one-year debt,...Ch. 16 - Marpor Industries has no debt and expects to...Ch. 16 - Real estate purchases are often financed with at...Ch. 16 - On May 14, 2008, General Motors paid a dividend of...Ch. 16 - Prob. 17PCh. 16 - Consider a firm whose only asset is a plot of...Ch. 16 - Prob. 19PCh. 16 - Prob. 20PCh. 16 - Prob. 21PCh. 16 - Consider the setting of Problem 21 , and suppose...Ch. 16 - Consider the setting of Problems 21 and 22, and...Ch. 16 - You own your own firm, and you want to raise 30...Ch. 16 - Empire Industries forecasts net income this coming...Ch. 16 - Ralston Enterprises has assets that will have a...Ch. 16 - Prob. 27PCh. 16 - If it is managed efficiently, Remel Inc. will have...Ch. 16 - Which of the following industries have low optimal...Ch. 16 - According to the managerial entrenchment theory,...Ch. 16 - Info Systems Technology (IST) manufactures...Ch. 16 - Prob. 32PCh. 16 - Prob. 33P
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- For each of the four questions below, identify whether the statement made in each question is correct or not and provide explanations. (b) When it comes to determining whether to take a project, the firm needs to calculate the NPV and assess the risk of it. For a highly leveraged firm, if the NPV is negative and the project is very risky, taking it is not beneficial for the firm. More specifically, the equity and debt holders will lose money because the overall firm value is highly likely decreased by that NPV.arrow_forwardA firm’s cost of capital is often a reflection of its activities and funding needs. Consider the case of Wizard Company, and answer the following questions: Wizard Co. currently has only a real estate division and uses only equity capital; however, it is considering creating consulting and distribution divisions. Its beta is currently 1.3. The risk-free rate is 4.4%, and the market risk premium is 6.2%. This means that the firm’s real estate division will have a cost of capital of: 10.12% 12.46% 3.08% 8.80% The consulting division is expected to have a beta of 2.1, because it will be riskier than the firm’s real estate division. This means that the firm’s consulting division will have a cost of capital of: 19.92% 18.77% 17.42% 18.37% The distribution division will have less risk than the firm’s real estate division, so its beta is expected to be 0.5. This means that the distribution division’s cost of…arrow_forwardACB Inc. is examining its capital structure with the intent of arriving at an optimal debt ratio. It currently has no debt and has a beta of 1.4. T-Bond rate is 7.5%. Your research indicates that the debt rating will be as follows at different debt levels: Your research indicates that the debt rating will be as follows at different debt levels: D/(D+E) Rating Interest rate 0% AAA 9.5% 10% AA 10% 20% 10.5% 30% BBB 11.5% 40% 12.5% 50% 13.5% 60% 15% 70% CC 18% 80% 20% 90% D 25% The firm currently has 2 million shares outstanding at $20 per share, and the tax rate is 35%. Assume an equity market risk premium of 6%. What is the firm's optimal debt ratio?arrow_forward
- Diol Athletics is trying to determine its optimal capital structure, which now consists of only debt and common equity. The firm does not currently use preferred stock in its capital structure, and it does not plan to do so in the future. To estimate how much its debt would cost at different debt levels, the company’s treasury staff has consulted with investment bankers and, on the basis of those discussions, has created the following table: Structure Market Debt-to-Value Ratio (Wd) Market Equity-to-Value Ratio (Ws) Bond Rating Pre-tax Cost of Debt (rd) A 0.0 1.0 AA 9.0% B 0.2 0.8 BBB 10.5% C 0.5 0.5 BB 11.6% D 0.6 0.4 C 12.7% E 0.75 0.25 D 14.0% Diol uses the CAPM to estimate its cost of common equity, rs. The company estimates that the risk-free rate is 7%; the market risk is 13%, and the company’s tax rate is 20%. Diol estimates that if it had no debt, its “unlevered” beta, bU, would be 1.3. What is the…arrow_forwardKyma Inc. currently has zero debt. It is a zero growth company, and it has the data shown below. Now the company is considering using some debt, moving to the new debt/assets ratio indicated below. The money raised would be used to repurchase stock at the current price. It is estimated that the increase in risk resulting from the additional leverage would cause the required rate of return on equity to rise somewhat, as indicated below. If this plan were carried out, by how much would the WACC change, i.e., what is WACCold - WACCNew? New Debt/Assets 35% Orig. cost of equity, rs 10.0% New Equity/Assets 65% New cost of equity = rs 11.0% Interest rate new = rd 7.0% Tax rate 40.0% O1.72% O2.06% 1.38% 1.04%arrow_forwardRoyal Paints Limited is an all-equity frim without any debt. It has a beta of 1.21. The current risk free rate is 8.5% and the historical market premium 9.5%. Royal is considering a project that is expected to generate a return of 20%. Assuming that the project has the same risk as the firm, should the accept the project? how to solve the question in excel?arrow_forward
- This question is related to Chapter 18 of Berk & Demarzo "Capital Budgeting and Valuation with Leverage". How do the calculations of the firm value using the APV method differ between the following assumptions? The growth rate of the EBIT and the debt-equity ratio will be constant The growth rate of the EBIT and the interest coverage ratio will be constant. The firm selects the optimal interest coverage ratio and maintains this ratio constant forever (corporate taxes are the only imperfection) Are the values that result different or equal?arrow_forwardIf a firm cannot invest retained earnings to earn a rate of returngreater than or equal to the required rate of return on retained earnings, it should return those funds to its stockholders. The cost of equity using the CAPM approach The current risk-free rate of return (rRFrRF) is 4.67% while the market risk premium is 5.75%. The Burris Company has a beta of 0.78. Using the capital asset pricing model (CAPM) approach, Burris’s cost of equity is . The cost of equity using the bond yield plus risk premium approach The Taylor Company is closely held and, therefore, cannot generate reliable inputs with which to use the CAPM method for estimating a company’s cost of internal equity. Taylor’s bonds yield 11.52%, and the firm’s analysts estimate that the firm’s risk premium on its stock over its bonds is 3.55%. Based on the bond-yield-plus-risk-premium approach, Taylor’s cost of internal equity is: 18.84% 15.07% 14.32% 18.08% The…arrow_forwardYour colleague collects the information in Table 1. Included are D/E ratios and estimated equity betas for firms similar to the take-over tarket, the target firm's Debt-to-Firm Value ratio, the target firm's tax rate, and the average YTM and coupon payments for their outstanding debt. Using this data, find the appropriate WACC for this investment decision. Hint: Firm Value is Debt + Equity. Therefore, D/(D+E) = 0.2. Use this to solve for D/E, the target firm's leverage ratio. D/E Equity Beta Target D/V 20% Competitor 1 29.90% 2.68 Tax Rate 40% Competitor 2 -7.60% 1.94 Average YTM 6% Competitor 3 32.20% 1.92 Average Coupon 6.50% Competitor 4 49.70% 1.12 Equity Market Risk Premium 5% Competitor 5 21.70% 0.97 Treasury Note 4.93% Competitor 6 34.30% 2.13 WACC Competitor 7 28.50% 1.27 Competitor 8 -6.70% 1.01 Competitor 9 42.60% 0.98arrow_forward
- Which of the following statements are incorrect regarding how much debt a company should borrow? Choose all that apply. Question 9 options: A As long as the company can generate higher returns on its new projects than its borrowing interest rate, borrowing more debt will enhance the company's ROE. B Borrowing more debt will increase a company's distress level. C The bigger the company, the more it should borrow D Debt is considered a more expensive capital source.arrow_forwardRoyal Paints Limited is an all-equity frimwithout any debt. It has a beta of 1.21. The current risk free rate is 8.5% and the historical market premium 9.5%. Royal is considering a project that is expected to generate a return of 20%. Assuming that the project has the same risk as the firm, should the accept the project? (solve using excel)arrow_forwardWhich of the following statements are CORRECT? Check all that apply: The aftertax cost of debt decreases when the market price of a bond increases. A decrease in a firm's WACC will increase the attractiveness of the firm's investment options. Cost of capital is also known as the minimum expected or required return an investment must offer to be attractive.arrow_forward
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