Financial Management: Theory & Practice
16th Edition
ISBN: 9780357296776
Author: Eugene F. Brigham, Michael C. Ehrhardt
Publisher: Cengage Learning US
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Chapter 21, Problem 3P
Summary Introduction
To calculate: The value of the levered firm using compressed adjusted
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An unlevered firm has a value of $850 million. An otherwise identical but levered firm has $80 million in debt at a 3% interest rate, which is its pre-tax cost of debt. Its unlevered cost of equity is 10%. After Year 1, free cash flows and tax savings are expected to grow at a constant rate of 4%. Assuming the corporate tax rate is 25%, use the compressed adjusted present value model to determine the value of the levered firm. (Hint: The interest expense at Year 1 is based on the current level of debt.) Enter your answer in millions. For example, an answer of $10,550,000 should be entered as 10.55. Do not round intermediate calculations. Round your answer to two decimal places.
Happy Time Inc. is expected to generate the following cash flows for the next year, as shown in the table below. Happy Time now only has one outstanding debt with
a face value of $110 million to be repaid in the next year. The current market value for the debt is $67 million. The tax rate is zero. If the firm is financed by common
equity and debt, what is the expected value of common equity next year?
Cash flow in the next year
Probability Amount
Economy
Boom
0.3
$110 million
Normal
0.4
$101 million
Recession 0.3
$61 million
$26.8 million
$24.7 million
$0
-$18.3 million
A company is financed with equity of $4.5 million and a bank loan of $2.5 million with an
interest rate of 8.6% per annum. The EBIT is $1.12 million. The applicable tax rate is 19%. Use
the above information to calculate the following:
a) change in the return on equity and the degree of financial leverage given a 15% increase
in EBIT next year,
b) change in the return on equity and the degree of financial leverage given a 5% decrease
in EBIT in the following year (the year following the year in which EBIT grew by 15%).
Chapter 21 Solutions
Financial Management: Theory & Practice
Ch. 21 - Prob. 1QCh. 21 - Modigliani and Miller assumed that firms do not...Ch. 21 -
An unlevered firm has a value of $500 million. An...Ch. 21 -
An unlevered firm has a value of $500 million. An...Ch. 21 - Prob. 3PCh. 21 - Prob. 4PCh. 21 - A company’s most recent free cash flow to equity...Ch. 21 - Air Tampa has just been incorporated, and its...Ch. 21 - Companies U and L are identical in every respect...Ch. 21 - Schwarzentraub Corporation’s expected free cash...
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- Please solve the below with detailed explanationarrow_forwardIn year 1, AMC will earn $2,200 before interest and taxes. The market expects these earnings to grow at a rate of 3.3% per year. The firm will make no net investments (i.e., capital expenditures will equal depreciation) or changes to net working capital. Assume that the corporate tax rate equals 25%. Right now, the firm has $5,500 in risk-free debt. It plans to keep a constant ratio of debt to equity every year, so that on average the debt will also grow by 3.3% per year. Suppose the risk-free rate equals 5.5%, and the expected return on the market equals 12.1%. The asset beta for this industry is 1.41. a. If AMC were an all-equity (unlevered) firm, what would its market value be? b. Assuming the debt is fairly priced, what is the amount of interest AMC will pay next year? If AMC's debt is expected to grow by 3.3% per year, at what rate are its interest payments expected to grow? c. Even though AMC's debt is riskless (the firm will not default), the future growth of AMC's debt is…arrow_forwardBelow is a firm's interest expenses in year 1, 2 and 3. After year 3, a firm's interest will grow at a constant rate of 4%. Firm's corporate tax rate is 40%. Firm's levered cost of equity is 10%, cost of debt is 2%. Firm is with 50% debt and 50% equity. What is the present value of interest tax shield using APV model? Interest Expense $79.09 million $61.35 million $68.12 million $73.02 million Year 1 $2 million Year 2 $3 million Year 3 $4 millionarrow_forward
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