EBK CORPORATE FINANCE
4th Edition
ISBN: 8220103164535
Author: DeMarzo
Publisher: PEARSON
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Textbook Question
Chapter 16, Problem 23P
Consider the setting of Problems 21 and 22, and suppose Petron Corp. must pay a 25% tax rate on the amount of the final payoff that is paid to equity holders. It pays no tax on payments to, or capital raised from, debt holders.
- a. Which strategy will Petron choose with no debt? Which will it choose with a face value of $10 million, $30 million, or $50 million in debt? (Assume management maximizes the value of equity, and in the case of ties, will choose the safer strategy.)
- b. Given your answer to (a), show that the total combined value of Petron’s equity and debt is maximized with a face value of $30 million in debt.
- c. Show that if Petron has $30 million in debt outstanding, shareholders can gain by increasing the face value of debt to $50 million, even though this will reduce the total value of the firm.
- d. Show that if Petron has $50 million in debt outstanding, shareholders will lose by buying back debt to reduce the face value of debt to $30 million, even though that will increase the total value of the firm.
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(Use the following information for the next three questions). Consider a
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B.F. Pierce & Company is considering changing its capital structure. The company currently
has no debt and no preferred stock, but it would like to add some debt to take advantage of
low interest rates and the tax shield. Its investment banker has indicated that the pre-tax
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8.66%
9.21%
8.83%
Market Debt-to-
Value Ratio
9.07%
(WD)
0.00
0.20
0.40
0.60
0.80
Market Equity-to-
Value Ratio
(WE)
1.00
0.80
0.60
0.40
0.20
Market Debt-to-
Equity Ratio
(D/E)
0.00
0.25
0.67
1.50
4.00
Before-Tax Cost of
Debt
(rD)
5.00%
The company uses the CAPM to estimate its cost of common equity. Currently the risk-free
rate is 4%, the market risk premium is 6%, and the company's tax rate is 25%. The company
estimates that its beta now (which is unlevered because it currently has no debt) is 0.8.
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6.00%
7.00%
8.00%
9.00%
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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