EBK CORPORATE FINANCE
11th Edition
ISBN: 8220102798878
Author: Ross
Publisher: YUZU
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Chapter 17, Problem 9QP
Personal Taxes, Bankruptcy Costs, and Firm Value When personal taxes on interest income and bankruptcy costs are considered, the general expression for the value of a levered firm in a world in which the tax rate on equity distributions equals zero is:
VL = Vu + {1–[(1 – tc)/(1 – tB)]}×B – C(B)
where:
VL = The value of a levered firm.
Vu = The value of an unlevered firm.
B = The value of the firm’s debt.
tc = The tax rate on corporate income.
tB= The personal tax rate on interest income.
C(B) = The
- a. In their no-tax model, what do Modigliani and Miller assume about tc tB, and C(B)? What do these assumptions imply about a firm’s optimal debt-equity ratio?
- b. In their model with corporate taxes, what do Modigliani and Miller assume about tc, tB, and C(B)? What do these assumptions imply about a firm’s optimal debt- equity ratio?
- c. Consider an all-equity firm that is certain to be able to use interest deductions to reduce its corporate tax bill. If the corporate tax rate is 34 percent the personal tax rate on interest income is 20 percent, and there are no costs of financial distress, by how much will the value of the firm change if it issues $1 million in debt and uses the proceeds to repurchase equity’?
- d. Consider another all-equity firm that does not pay taxes due to large tax loss earryforwards from previous years. The personal tax rate on interest income is 20 percent, and there are no costs of financial distress. What would be the change in the value of this firm from adding $1 of perpetual debt rather than $1 of equity?
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Use the following information to answer this question:
Net sales
Windswept, Incorporated
2024 Income Statement
Cost of goods sold
Depreciation
($ in millions)
Earnings before interest and taxes
Interest paid
Taxable income
Taxes
Net income
$ 14,150
8,150
515
$ 5,485
108
$ 5,377
1,129
$ 4,248
Windswept, Incorporated
2023 and 2024 Balance Sheets
($ in millions)
2023
2024
2023
2024
Cash
Accounts received
$ 300
$ 330
Accounts payable
$ 1,980
$1,955
1,190
1,090
Long-term debt
1,110
1,430
Inventory
2,120
1,795
Common stock
3,440
3,080
Total
$ 3,610
$ 3,215
Retained earnings
690
940
Net fixed assets
3,610
Total assets
$ 7,220
4,190
$ 7,405
Total liabilities & equity
$ 7,220
$ 7,405
What is the fixed asset turnover for 2024?
Chapter 17 Solutions
EBK CORPORATE FINANCE
Ch. 17 - Bankruptcy Costs What are the direct and indirect...Ch. 17 - Stockholder Incentives Do you agree or disagree...Ch. 17 - Capital Structure Decisions Due to large losses...Ch. 17 - Cost of Debt What steps can stockholders take to...Ch. 17 - MM and Bankruptcy Costs How does the existence of...Ch. 17 - Agency Costs of Equity What are the sources of...Ch. 17 - Observed Capital Structures Refer to the observed...Ch. 17 - Bankruptcy and Corporate Ethics As mentioned in...Ch. 17 - Bankruptcy and Corporate Ethics Finns sometimes...Ch. 17 - Prob. 10CQ
Ch. 17 - Firm Value Janetta Corp. has EBIT of 5850,000 per...Ch. 17 - Agency Costs Tom Scott is the owner, president and...Ch. 17 - Nonmarketed Claims Dream, Inc., has debt...Ch. 17 - Prob. 4QPCh. 17 - Capital Structure and Growth Edwards Construction...Ch. 17 - Prob. 6QPCh. 17 - Agency Costs Fountain Corporations economists...Ch. 17 - Financial Distress Good Time Company is a regional...Ch. 17 - Personal Taxes, Bankruptcy Costs, and Firm Value...Ch. 17 - Personal Taxes, Bankruptcy Costs, and Firm Value...Ch. 17 - What is the expected value of the company in one...Ch. 17 - Prob. 2MCCh. 17 - One year from now, how much value creation is...Ch. 17 - Prob. 4MCCh. 17 - Prob. 5MCCh. 17 - Prob. 6MC
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