FIN 401 Lecture Notes - Lecture 5: Market Timing, Net Present Value, Tax Rate

101 views7 pages

danotehustla

1 Mar 2018

School

Department

Course

Professor

For unlimited access to Class Notes, a Class+ subscription is required.

Document Summary

Debt and taxes: market imperfections can create a role for the capital structure, corporate taxes, corporations can deduct interest expenses, reduces taxes paid. Imagine that your firm is choosing between two capital structures: one is all-equity and the other has a mix of debt and equity. The levered option would have ,000 in. In both cases, your firm will have an annual. Your firm faces a 40% tax rate. Interest tax shield: the reduction in taxes paid due to the tax deductibility of interest payments. Interest tax shield = corporate tax rate x interest expense. Humza j: to determine the benefit, compute the present value of the stream of future interest tax shields. Value of the interest tax shield m&m prop. Your firm is going to borrow million by issuing 15-year bonds. Your firm"s cost of debt is 7% and its marginal tax rate will remain at 40% for at least the next 15 years.

Related Questions

1. Your company pays interest on its 3 year, 6% coupon rate debt as follows: Year 1: $50 million Year 2: $40 million Year 3: $30 million The tax rate is 40%. What is the present value of the interest tax shield if the discount rate is 8%? 48 mil 41.76 mil 52.23 mil 32.18 mil

2. How does the interest deduction from taxes affect the conclusions of the MM Propositions? Firm value increases with leverage but WACC remains constant. Firm value decreases with leverage, and WACC is unaffected. Firm value decreases with leverage, and WACC inreases with leverage. Firm value increases with leverage and WACC decreases with leverage..

3.Which of the following is true about agency considerations in finding the optimal capital structure for a firm? No answer text provided. Outside equity costs more than debt, and debt costs more than retained earnings due to information asymmetry. Therefore, finance project with retained earnings first, debt second, and outside equity last. Through their control of management, stockholders will take more risk than what is in bondholders' interets. The optimal level of debt is determined by trading off the benefits of deducting interest from taxes and the costs of financial distress.

skyhedgehog100

F2 Q19-20

19.

You are working on a big new idea for your firm. You have projected an EBIT of $5 million starting next year (t = 1) with a growth rate of 3.50% over the foreseeable future thereafter. This endeavor will require a substantial investment and you will have to convince investors to provide you the capital to do so. Your firm will consider all types of financing options, but the first critical step in your analysis is figuring out the present value of the cash flows of the new business. Your research has revealed the following information: similar businesses have a beta asset of 2.00, the risk-free rate is 2.00% and the expected market risk premium (the average difference between the market return and the risk-free rate) is 3.50%. The corporate tax rate is 35% and interest payments on debt are tax deductible. You are tasked to figure out the value of the business under various financing alternatives, including long-term loan/debt. You have considered a loan of $25 million in perpetuity at an interest rate of 4%. Realizing that the chances of bankruptcy are negligible with this amount of ongoing debt on your balance sheet, and the riskiness of the tax shield of debt is the same as the riskiness of debt, you decide to take on $25 million of debt in perpetuity. Given this decision, you want to consider the Multiples Approach to Valuation as a double-check for your detailed Discounted Cash Flow (DCF) Based analyses. Fortunately, there have been several market transactions in this business environment using various capital structures, but you want to choose the most optimal multiple to use given your decision to use a specific capital structure. The best multiple to use will be:

a. P/E Multiple.

b. Either one is suitable for your situation.

c. EBITDA Multiple.

d. Neither one is suitable for your situation.

20.

You are working on a big new idea for your firm. You have projected an EBIT of $5 million starting next year (t = 1) with a growth rate of 3.50% over the foreseeable future thereafter. This endeavor will require a substantial investment and you will have to convince investors to provide you the capital to do so. Your firm will consider all types of financing options, but the first critical step in your analysis is figuring out the present value of the cash flows of the new business. Your research has revealed the following information: similar businesses have a beta asset of 2.00, the risk-free rate is 2.00% and the expected market risk premium (the average difference between the market return and the risk-free rate) is 3.50%. The corporate tax rate is 35% and interest payments on debt are tax deductible. You are tasked to figure out the value of the business under various financing alternatives, including long-term loan/debt. You have considered a loan of $25 million in perpetuity at an interest rate of 4%. Realizing that the chances of bankruptcy are negligible with this amount of ongoing debt on your balance sheet, and the riskiness of the tax shield of debt is the same as the riskiness of debt, you decide to take on $25 million of debt in perpetuity. Congress however is seriously contemplating modifying the tax subsidy to only debt, that is, the deductibility of interest from earnings before taxes are calculated. They instead will also allow dividend payments to be tax deductible, making giving both forms of financing the same tax status. Given this information, and assuming that costs of bankruptcy are likely to be negligible, you should:

a. Change your capital structure increase the amount of equity.

b. Not worry about your capital structure and focus on the drivers of your business.

c. Keep your capital structure unchanged because all your previous analysis will remain valid.

BTR Warehousing, which is considering the acquiition of Galaxy Sun Corp., estimates that acquiring Galaxy Sun will result in an incremental value for the firm. The analysts involved in the deal have collected the following information from the projected financial statements of the target company:

Data collected (in millions of dollars)

	Year 1	Year 2	Year 3
EBIT	$14.0	$16.8	$21.0
Interest Expense	4.0	4.4	4.8
Debt	31.9	37.7	40.6
Total net operating capital	121.5	123.9	126.3

Galaxy Sun Corp. is a publicly traded company, and its market-determined pre-merger beta is 1.20. You also have the following information about the company and the projected statements:

a) Galaxy Sun currently has a $32.00 million market value of equity and $ 20.80 million in debt.

b) The risk-free rate is 4%, there is a 6.10% market risk premium, and the capital aset pricing model purchases a pre-merger required rate of return on equity of 11.32%.

c) Galaxy Sun's cost of debt is 6.00% at a tax rate of 35%.

d) The projections assume that the company will have a post-horizon growth rate of 5.00%.

e) Current total net operating capital is $118.0, and the sum of existing debt and debt required to maintain a constant capital structure at the time of acquisitionis $29 million.

f) The firm does not have any nonoperating assets such as marketable securities.

Given this information, use the adjusted present value (APV) approach to calculate the following values involved in merger analysis:

1. Unlevered cost of equity: 8.10%/ 6.82% / 9.22% / 10.50%

2. Horizontal value of unlevered cash flows: $211.99 million / $279.92 million / $266.59 million / $132.70 million

3. Horizontal value of tax shield: $41.80 million / $39.81 million / $66.35 million / $38.32 million

4. Unlevered value of operations: $64.28 million / $233.62 million / $235.75 million / $228.61 million

5. Value of tax shield: $35.94 million / $74.66 million / $62.57 million / $39.65 million

6. Value of operations: $138.94 million / $271.69 million / $268.26 million / $296.19 million

7. Thus, the total value of Galaxy Sun's equity is $250.89 million / $214.95 million / $43.48 million / $275.39 million

8. Supposse BTR Warehousing plans to use more debt in the first few years of theacquisition of Galaxy Sun Corp. Assuming that using more debt will not lead to an increse in bankruptcy costs for BTR Warehousing, the interest tax shields and tha value of the tax shield in the analyssis, will decrease / increase, leading to a higher / lower value of operations of the acquired firm.

9. The APV approach is considered useful for valuing acquisition targets, because the method involves finding the values of the unlevered firm and the interest tax shield separately and then summing those values. Why is it difficult to value certain types of acquisitions using the corporate valuation model?

- The acquiring firm immediately retires the target firm's old debt. Thus, the acquisition deal consists of only new debt in its capital structure.

- The acquiring firm usually assumes the debt of the target firm. Thus, old debt with different coupon rates usually becomes a part of the aquisition deal.

coppergnat492

FIN 401 Lecture Notes - Lecture 5: Market Timing, Net Present Value, Tax Rate

Document Summary

Get access

Related Documents

FIN 401 Lecture 5: FIN401 - Class 5 Notes Part 2

FIN 401 Lecture Notes - Lecture 5: M-Theory, Retained Earnings, Managerial Finance

FIN 401 Chapter 16: FIN401 - Chapter 16 Textbook Notes Part 2

Related Questions