Fundamentals of Corporate Finance
11th Edition
ISBN: 9780077861704
Author: Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Bradford D Jordan Professor
Publisher: McGraw-Hill Education
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Chapter 14, Problem 21QP
Flotation Costs [LO4] Pardon Me, Inc., recently issued new securities to finance a new TV show. The project cost $30 million, and the company paid $1.9 million in flotation costs. In addition, the equity issued had a flotation cost of 7 percent of the amount raised, whereas the debt issued had a flotation cost of 3 percent of the amount raised. If the company issued new securities in the same proportion as its target capital structure, what is the company’s target debt–equity ratio?
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Please help answer this:
Company XYZ is planning to repurchase part of its stock by issuing corporate debt. The firm’s debt-equity ratio will rise from 40% to 50 %. Currently, the firm has 50,000 debt outstanding. The cost of debt is 20% per year. The firm expects to have an EBIT of 25,000 per year in perpetuity. The firm XYZ pays no taxes. (You might need to use Modigliani-Miller Propositions to answer some of the questions.)
a) What is the market value of firm XYZ before and after the stock repurchase?
b) What is the expected return on the firm’s equity (ROE) before the announcement of the stock repurchase plan?
c) What is the expected return on the equity of an identical all-equity firm?
d) What is the expected return on the firm’s equity after the announcement of the stock repurchase plan?
Chapter 14 Solutions
Fundamentals of Corporate Finance
Ch. 14.1 - What is the primary determinant of the cost of...Ch. 14.1 - What is the relationship between the required...Ch. 14.2 - What do we mean when we say that a corporations...Ch. 14.2 - Prob. 14.2BCQCh. 14.3 - Why is the coupon rate a bad estimate of a firms...Ch. 14.3 - How can the cost of debt be calculated?Ch. 14.3 - How can the cost of preferred stock be calculated?Ch. 14.4 - Prob. 14.4ACQCh. 14.4 - Prob. 14.4BCQCh. 14.4 - Under what conditions is it correct to use the...
Ch. 14.5 - Prob. 14.5ACQCh. 14.5 - Prob. 14.5BCQCh. 14.6 - Prob. 14.6ACQCh. 14.6 - Why do you think we might prefer to use a ratio...Ch. 14.7 - What are flotation costs?Ch. 14.7 - How are flotation costs included in an NPV...Ch. 14 - A firm has paid dividends of 1.02, 1.10, 1.25, and...Ch. 14 - Prob. 14.3CTFCh. 14 - Why is the tax rate applied to the cost of debt...Ch. 14 - What approach to a projects costs of capital...Ch. 14 - What is the flotation cost of equity for a firm...Ch. 14 - WACC [LO3] On the most basic level, if a firms...Ch. 14 - Book Values versus Market Values [LO3] In...Ch. 14 - Project Risk [LO5] If you can borrow all the money...Ch. 14 - Prob. 4CRCTCh. 14 - DCF Cost of Equity Estimation [LO1] What are the...Ch. 14 - SML Cost of Equity Estimation [LO1] What are the...Ch. 14 - Prob. 7CRCTCh. 14 - Cost of Capital [LO5] Suppose Tom OBedlam,...Ch. 14 - Company Risk versus Project Risk [LO5] Both Dow...Ch. 14 - Divisional Cost of Capital [LO5] Under what...Ch. 14 - Calculating Cost of Equity [LO1] The Absolute Zero...Ch. 14 - Calculating Cost of Equity [LO1] The Graber...Ch. 14 - Calculating Cost of Equity [LO1] Stock in Daenerys...Ch. 14 - Estimating the DCF Growth Rate [LO1] Suppose...Ch. 14 - Prob. 5QPCh. 14 - Calculating Cost of Debt [LO2] Drogo, Inc., is...Ch. 14 - Calculating Cost of Debt [LO2] Jiminys Cricket...Ch. 14 - Prob. 8QPCh. 14 - Calculating WACC [LO3] Mullineaux Corporation has...Ch. 14 - Taxes and WACC [LO3] Lannister Manufacturing has a...Ch. 14 - Finding the Target Capital Structure [LO3] Famas...Ch. 14 - Book Value versus Market Value [LO3] Dinklage...Ch. 14 - Calculating the WACC [LO3] In Problem 12, suppose...Ch. 14 - WACC [LO3] Fyre, Inc., has a target debtequity...Ch. 14 - Prob. 15QPCh. 14 - Prob. 16QPCh. 14 - SML and WACC [LO1] An all-equity firm is...Ch. 14 - Calculating Flotation Costs [LO4] Suppose your...Ch. 14 - Calculating Flotation Costs [LO4] Caughlin Company...Ch. 14 - WACC and NPV [LO3, 5] Scanlin, Inc., is...Ch. 14 - Flotation Costs [LO4] Pardon Me, Inc., recently...Ch. 14 - Calculating the Cost of Debt [LO2] Ying Import has...Ch. 14 - Calculating the Cost of Equity [LO1] Epley...Ch. 14 - Adjusted Cash Flow from Assets [LO3] Ward Corp. is...Ch. 14 - Adjusted Cash Flow from Assets [LO3] In the...Ch. 14 - Prob. 26QPCh. 14 - Prob. 27QPCh. 14 - Flotation Costs and NPV [LO3, 4] Photochronograph...Ch. 14 - Flotation Costs [LO4] Sheaves Corp. has a...Ch. 14 - Project Evaluation [LO3, 4] This is a...Ch. 14 - Prob. 31QPCh. 14 - Prob. 1MCh. 14 - Cost of Capital for Swan Motors You have recently...Ch. 14 - Prob. 3MCh. 14 - Cost of Capital for Swan Motors You have recently...Ch. 14 - Cost of Capital for Swan Motors You have recently...
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- D4) Finance The Grant Corporation is considering permanently adding $500 million of debt to its capital structure. Grant's corporate tax rate is 35% and investors pay a tax rate of 40% on their interest income and 20% on their income from capital gains and dividends. Using Miller’s (1977) model calculate the present value of the interest tax shield provided by this new debt. Please round your answer to the nearest 0.01. 33.33 million 50.00 million 66.67 million 80 million None of the abovearrow_forwardSuppose the company Powerland borrows the new $2 million debt as perpetual bonds at a 5% cost which is equal to the risk-free rate (rf). If Corporate Income Tax rate is 23% rate and the Personal Tax for Debtholders is 5%, by how much does the interest tax shield increase the value of Powerland? a. $1,621,053 b. $100.000 C. - $100,000 d. $460,000arrow_forward30. Trade-Off Theory. Smoke and Mirrors currently has EBIT of $25,000 and is all-equity- financed. EBIT is expected to stay at this level indefinitely. The firm pays corporate taxes equal to 21% of taxable income. The discount rate for the firm's projects is 10%. (LO16-3) a. What is the market value of the firm? b. Now assume the firm issues $50,000 of debt paying interest of 6% per year, using the proceeds to retire equity. The debt is expected to be permanent. What will happen to the total value of the firm (debt plus equity)? c. Recompute your answer to part (b) under the following assumptions: The debt issue raises the probability of bankruptcy. The firm has a 30% chance of going bankrupt after 3 years. If it does go bankrupt, it will incur bankruptcy costs of $200,000. The discount rate is 10%. d. Should the firm issue the debt under these new assumptions?arrow_forward
- 4 Landman Corporation (LC) manufactures time series photographic equipment. It is currently at its target debt-equity ratio of 63. It's considering building a new $65.3 million manufacturing facility. This new plant is expected to generate aftertax cash flows of $7.89 million in perpetulty. There are three financing options: a. A new issue of common stock. The required return on the company's new equity is 15.3 percent. b. A new issue of 20-year bonds. If the company issues these new bonds at an annual coupon rate of 7.4 percent, they will sell at par c. increased use of accounts payable financing Because this financing is part of the company's ongoing daily business, the company assigns it a cost that is the same as the overall firm WACC Management has a target ratio of accounts payable to long-term debt of 11. (Assume there is no difference between the pretax and aftertax accounts payable cost) If the tax rate is 23 percent, what is the NPV of the new plant? Note: A negative answer…arrow_forwardfinance its new project, Old Habits Inc. needs $5M that will be raised by issuing 6-year bonds. The interest rate on the bonds is 7% and the bonds will be issued at par. The flotation costs will be covered from the proceeds of the bond issue and are 2.5% of the gross proceeds. Find the NPV of flotation costs if the tax rate is 25%. "-93,751" "-61,020" "-40,474" "-81,775" "-102,743"arrow_forward1. Enya Company is planning to repurchase part of its common stock by issuing corporate debt. As a result, the firm’s debt–equity ratio is expected to rise from 40 percent to 50 percent. The firm currently has RM4.3 million worth of debt outstanding. The cost of this debt is 10 percent per year. Enya expects to have an EBIT of RM1.68 million per year in perpetuity. Enya pays no taxes. 1. What is the expected return on the firm’s equity before the announcement of the stock repurchase plan? 2. What is the expected return on the equity of an otherwise identical all-equity firm? 3. What is the expected return on the firm’s equity after the announcement of the stock repurchase plan? answer question 1-3arrow_forward
- (1).Ship Shape Marine (SSM) needs $92 million to support future growth. If SSM issues bonds to raise funds, flotation (issuance) costs will be 8 percent. Each bond will be sold for $1,000; fractions of bonds cannot be issued. How many bonds must be issued so that SSM has $92 million after flotation costs to use for its planned growth? 108,000 92,000 84,640 99,360 100,000arrow_forwardXYZ company issued new securities to finance a new TV show. The project cost 500000and debt-to-equity ratio is 0.9 the flotation cost is 0.06for the equity and the flotation cost for debt is 0.02 if you want to raise money from equity and debt, what is the total flotation cost for the firm? what is the total amount to be raised? if you want to raise money from equity and debt, what is the total flotation cost for the firm? what is the total amount to be raised?arrow_forwardGoodbye Inc. recently issued new securities to finance a new TV show. The project cost $19 million, and the company paid $1,150,000 in flotation costs. In addition, the equity issued had a flotation cost of 7 percent of the amount raised, whereas the debt issued had a flotation cost of 3 percent of the amount raised. If Goodbye issued new securities in the same proportion as its target capital structure, what is the company's target debt-to-equity ratio? (Round your intermediate calculations to 4 decimal places. Round the final answer to 4 decimal places.) Debt-equity ratioarrow_forward
- (19) Smoke and Mirrors currently has EBIT of $25,000 and is all-equity financed. EBIT is expected to stay at this level indefinitely. The firm pays corporate taxes equal to 21% of taxable income. The discount rate for the firm's projects is 10%. Now assume the firm issues $50,000 of debt paying interest of 6% per year, using the proceeds to retire equity. The debt is expected to be permanent. What will happen to the total value of the firm (debt plus equity)?arrow_forwardJudson Inc. recently issued new securities to finance a new TV show. The project cost $14.8 million, and the company paid $805,000 in flotation costs. In addition, the equity issued had a flotation cost of 7.8% of the amount raised, whereas the debt issued had a flotation cost of 3.8% of the amount raised. If Judson issued new securities in the same proportion as its target capital structure, what is the company's target debt-equity ratio? (Do not round intermediate calculations. Round the final answer to 4 decimal places.) Debt-Equity ratioarrow_forwardMC.10.081 You were hired as a consultant to Quigley Company, whose target capital structure is 35% debt, 10% preferred, and 55% common equity. The interest rate on new debt is 6.50%, the yield on the preferred is 6.00%, the cost of retained earnings is 10.50%, and the tax rate is 25%. The firm will not be issuing any new stock. What is Quigley's WACC? Round final answer to two decimal places. Do not round your intermediate calculations. O a. 8.65% Ob. 7.13% O c.7.48% O d. 8.08% O e. 6.49% Q Search H U 0 O N M K 19-1-4 hp alt 25 CO a 66 W ITIS prt sc pause ← X delete backspace Question 47 of 75 A home enter num lock ↑ shift 3:51 PM 11/1/2023 end 7 home endarrow_forward
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What is WACC-Weighted average cost of capital; Author: Learn to invest;https://www.youtube.com/watch?v=0inqw9cCJnM;License: Standard YouTube License, CC-BY