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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.

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Sixta Kovacek
Sixta KovacekLv2
28 Sep 2019

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Pettit Printing Company has a total market value of $100 million, consisting of 1 million shares selling for $50 per share and $50 million of 10% perpetual bonds now selling at par. The company's EBIT is $11.03 million, and its tax rate is 15%. Pettit can change its capital structure either by increasing its debt to 60% (based on market values) or decreasing it to 40%. If it decides to increase its use of leverage, it must call its old bonds and issue new ones with a 12% coupon. If it decides to decrease its leverage, it will call in its old bonds and replace them with new 7% coupon bonds. The company will sell or repurchase stock at the new equilibrium price to complete the capital structure change. The firm pays out all earnings as dividends; hence, its stock is a zero growth stock. Its current cost of equity, rs, is 14%. If it increases leverage, rs will be 16%. If it decreases leverage, rs will be 13%. Present situation (50% debt): What is the firm's WACC? Round your answer to three decimal places. % What is the total corporate value? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to three decimal places. $ million 60% debt: What is the firm's WACC? Round your answer to two decimal places.   % What is the total corporate value? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to three decimal places. $ million 40% debt: What is the firm's WACC? Round your answer to two decimal places.   % What is the total corporate value? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to three decimal places. $ million

Capital Structure Analysis

Pettit Printing Company has a total market value of $100 million, consisting of 1 million shares selling for $50 per share and $50 million of 10% perpetual bonds now selling at par. The company's EBIT is $14.09 million, and its tax rate is 40%. Pettit can change its capital structure either by increasing its debt to 65% (based on market values) or decreasing it to 35%. If it decides to increase its use of leverage, it must call its old bonds and issue new ones with a 12% coupon. If it decides to decrease its leverage, it will call in its old bonds and replace them with new 8% coupon bonds. The company will sell or repurchase stock at the new equilibrium price to complete the capital structure change.

The firm pays out all earnings as dividends; hence, its stock is a zero growth stock. Its current cost of equity, rs, is 14%. If it increases leverage, rs will be 16%. If it decreases leverage, rs will be 13%.

Present situation (50% debt):
What is the firm's WACC? Round your answer to three decimal places.
%
What is the total corporate value? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to three decimal places.
$ million

65% debt:
What is the firm's WACC? Round your answer to two decimal places.
  %
What is the total corporate value? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to three decimal places.
$ million

35% debt:
What is the firm's WACC? Round your answer to two decimal places.
  %
What is the total corporate value? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to three decimal places.
$ million

Which of the following statements is most correct?

If a firm is exposed to a high degree of business risk as a result of its high operating leverage, then it probably should offset this risk by using a larger-than-average amount of financial leverage. This follows because debt has a lower after-tax cost than equity.

Financial risk can be reduced by replacing common equity with preferred stock.

The Hamada equation specifies the effect of financial leverage on beta. It shows how increases in the debt/equity ratio lowers beta.

In the textbook, it was stated that the capital structure that minimizes the WACC also maximizes the firm’s stock price and its total value, but generally not its expected EPS. One reason given for why debt is beneficial is that it shelters operating income from taxes, while it was stated that a disadvantage of excessive debt has to do with costs associated with bankruptcy and financial distress generally.

All of the above statements are false.

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