fin3403 ch16 hw

A firm will give a one-time cash flow of $24,000 after one year. If the project risk requires a return of 10%, what is the levered value of the firm with perfect capital markets?

$21,818.18 Find the PV of the cash flow. I = 10% N = 1 Pmt = -24000 PV = 21,818.18

Suppose a project financed via an issue of debt requires six annual interest payments of $18 million each year. If the tax rate is 35% and the cost of debt is 8%, what is the value of the interest rate tax shield?

$29.12 million tax shield = 18 x .35 = 6.3 Use excel to find PV of tax shield I = 8% N = 6 Pmt = 6.3 PV = 29.12

Consider two firms, Firm X and Firm Y, that have identical assets that generate identical cash flows. Firm Y is an all-equity firm, with 1 million shares outstanding that trade for a price of $24 per share. Firm X has 2 million shares outstanding and $12 million in debt at an interest rate of 5%. According to MM Proposition I, the stock price for Firm X is closest to ________.

$6.00 12,000,000/2000000 = $6 ????????????????????????????

Which of the following does a firm consider in the choice of securities issued?

-the tax consequences of the chosen security -the transactions costs of the chosen security -whether the chosen security will have a fair price in the market

A firm has a market value of equity of $40,000. It borrows $8000 at 7%. If the unlevered cost of equity is 16%, what is the firm's cost of equity capital?

17.8% 8000*.07 = 560 560/40000 = 0.014 .16 + .014 = .174

A firm has a market value of equity of $30,000. It borrows $7500 at 8%. If the unlevered cost of equity is 16%, what is the firm's cost of equity capital?

18.0% 7500*.08 = 600 600/30000 = .02 .16 + .02 = .18 or 18%

A firm requires an investment of $25,000 and will return $36,500 after 1 year. If the firm borrows $20,000 at 7%, what is the return on levered equity?

202% equity = investment - debt =25000-20000 = 5000 debt repay = debt x 1.07 =20000(1.07) =21400 Cash flow = return - debt repay =36500 - 21400 =15100 Return on levered equity = (cash flow-equity)/equity (15100-5000)/5000 =2.02

A firm requires an investment of $20,000 and will return $26,500 after one year. If the firm borrows $6000 at 7%, what is the return on levered equity?

43% Debt repay = 6000*1.07 = 6420 Cash flow = return - debt repay Equity = investment - debt =(cash flow - equity)/equity =(20080-14000)/14000 =0.434

Weak- $25000 Expected- $35000 Strong- $45000 Suppose the above company has only one project, as forecast above, and an unlevered cost of equity of 8%. If the company uses no leverage, what is expected return to equity holders?

8%

A firm requires an investment of $18,000 and will return $25,000 after one year. If the firm borrows $10,000 at 6%, what is the return on levered equity?

80% Equity = 18000-10000 = 8000 Debt repay = 10000(1.06) = 10600 Cash flow = 25000 - 10600 = 14400 Return on levered equity = (Cash flow-equity)/equity (14400-8000)/8000 =0.8

The Tradeoff Theory suggests that

a firm should choose a debt level where the tax savings from increasing leverage are just offset by the increased probability of incurring the costs of financial distress

A firm's ________ ratio is the fraction of the firm's total value that corresponds to debt.

debt to value

A financial manager makes a choice of the amount and source of capital based on how the choice will impact the ________.

firm value

MM Proposition I states that in a perfect capital market the total value of a firm is equal to the market value of the ________ generated by its assets.

free cash flows

By adding leverage, the returns on a firm are split between debt holders and equity holders, but equity holder risk increases because ________.

interest payments have first priority

It is not correct to discount the cash flows of a levered firm with the cost of equity of the unlevered firm because ________.

leverage increases the risk of the equity of the firm

Equity in a firm that also has debt in their capital structure is called ________.

levered equity

Aside from direct costs of bankruptcy, a firm may also incur other indirect costs such as ________.

loss of customers and loss of suppliers

Asymmetric information implies that ________ may have better information about a firm's cash flows than other stakeholders.

managers

Investment cash flows are independent of financing choices in a ________.

perfect capital markets

One of the factors that determine the present value (PV) of financial distress costs is ________.

probability of financial distress

According to researchers Modigliani and Miller, with perfect capital markets, the total value of a firm should not depend on its capital structure.

true

Equity in a firm with no debt is called _______

unlettered equity