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 17, Problem 13QP
Expected Return, Dividends, and Taxes [LO2] The Gecko Company and the Gordon Company are two firms whose business risk is the same but that have different dividend policies. Gecko pays no dividend, whereas Gordon has an expected dividend yield of 3.5 percent. Suppose the
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Assume an M&M world with taxes. Your company's EBIT is currently $20,000,000, and EBIT is
expected to remain constant over time (zero growth). The company pays out all of its earnings each
year, so its earnings per share equals its dividends per share. The firm has 6,000,000 shares
outstanding. The risk-free rate in the economy is 2.5 percent, and the market risk premium is 5.0
percent. The company's beta is currently 1.50. And, of course, the tax rate is 40%. Currently, the
firm as no debt outstanding.
The company decided to issue $X million worth of debt, and to use the proceeds to repurchase
shares in the open market. When the announcement of the debt issue was made yesterday, the
stock price reacted appropriately, increasing by 8%. The firm then issued the debt and repurchased
the shares as planned.
What is the final beta of the firm's equity? You should use all M&M assumptions for this answer.
Answer in X.XX format. For example, a final beta of 1.0356 should be entered as 1.04.
The Gecko Company and the Gordon Company are two firms whose business risk is the same but that
have different dividend policies. Gecko pays no dividend, whereas Gordon has an expected dividend yield
of 7 percent. Suppose the capital gains tax rate is zero, whereas the income tax rate is 40 percent. Gecko
has an expected earnings growth rate of 16 percent annually, and its stock price is expected to grow at this
same rate. If the aftertax expected returns on the two stocks are equal (because they are in the same risk
class), what is the pretax required return on Gordon's stock?
Note: Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal
places, e.g., 32.16.
Pretax return
%
Suppose the corporate tax rate is 30%. Consider a firm that earns $1,000 in earnings before interest and taxes each year with no risk. The firm's capital expenditures equal its depreciation expenses each year, and it will have no changes to its
net working capital. The risk-free interest rate is 4%.
a. Suppose the firm has no debt and pays out its net income as a dividend each year. What is the value of the firm's equity?
b. Suppose instead the firm makes interest payments of $700 per year. What is the value of equity? What is the value of debt?
c. What is the difference between the total value of the fim with leverage and without leverage?
d. To what percentage of the value of the debt is the difference in part (c) equal?
a. Suppose the firm has no debt and pays out its net income as a dividend each year. What is the value of the firm's equity?
If the firm has no debt and pays out its net income as a dividend each year, the value of the firm's equity is $. (Round to the nearest…
Chapter 17 Solutions
Fundamentals of Corporate Finance
Ch. 17.1 - Prob. 17.1ACQCh. 17.1 - What are the mechanics of the cash dividend...Ch. 17.1 - How should the price of a stock change when it...Ch. 17.2 - How can an investor create a homemade dividend?Ch. 17.2 - Prob. 17.2BCQCh. 17.3 - Prob. 17.3ACQCh. 17.3 - Why do flotation costs favor a low payout?Ch. 17.4 - Why might some individual investors favor a high...Ch. 17.4 - Prob. 17.4BCQCh. 17.5 - How does the market react to unexpected dividend...
Ch. 17.5 - Prob. 17.5BCQCh. 17.6 - Prob. 17.6ACQCh. 17.6 - Prob. 17.6BCQCh. 17.8 - Prob. 17.8ACQCh. 17.8 - How does the accounting treatment of a stock split...Ch. 17 - Dividends are paid to the parties listed as...Ch. 17 - Prob. 17.3CTFCh. 17 - Prob. 17.4CTFCh. 17 - Prob. 17.8CTFCh. 17 - Dividend Policy Irrelevance [LO2] How is it...Ch. 17 - Prob. 2CRCTCh. 17 - Prob. 3CRCTCh. 17 - Prob. 4CRCTCh. 17 - Prob. 5CRCTCh. 17 - Prob. 6CRCTCh. 17 - Prob. 7CRCTCh. 17 - Prob. 8CRCTCh. 17 - Prob. 9CRCTCh. 17 - Prob. 10CRCTCh. 17 - Prob. 1QPCh. 17 - Prob. 2QPCh. 17 - Prob. 3QPCh. 17 - Prob. 4QPCh. 17 - Regular Dividends [LO1] The balance sheet for...Ch. 17 - Prob. 6QPCh. 17 - Prob. 7QPCh. 17 - Stock Dividends [LO3] The company with the common...Ch. 17 - Stock Splits [LO3] In the previous problem,...Ch. 17 - Homemade Dividends [LO2] You own 1,000 shares of...Ch. 17 - Prob. 11QPCh. 17 - Stock Repurchase [LO4] Galles Corporation is...Ch. 17 - Expected Return, Dividends, and Taxes [LO2] The...Ch. 17 - Dividends and Taxes [LO2] As discussed in the...Ch. 17 - Prob. 15QPCh. 17 - Dividends versus Reinvestment [LO2] After...Ch. 17 - Prob. 1MCh. 17 - Prob. 2MCh. 17 - Prob. 3MCh. 17 - Prob. 4MCh. 17 - Prob. 5MCh. 17 - Prob. 6M
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- [EXCEL] Zero growth: Ron Santana is interested in buying the stock of First National Bank. While the bank's management expects no growth in the near future, Ron is attracted by the dividend income. Last year the bank paid a dividend of $5.65. If Ron requires a return of 14 percent on such stocks, what is the maximum price he should be willing to pay for a share of the bank's stock?arrow_forward5. Problem 14.07 (Financial Leverage Effects) The Neal Company wants to estimate next year's return on equity (ROE) under different financial leverage ratios. Neal's total capital is $19 million, it currently uses only common equity, it has no future plans to use preferred stock in its capital structure, and its federal-plus-state tax rate is 25%. Neal is a small firm with average sales of $25 million or less during the past 3 years, so it is exempt from the interest deduction limitation. The CFO has estimated next year's EBIT for three possible states of the world: $4.8 million with a 0.2 probability, $3.5 million with a 0.5 probability, and $700,000 with a 0.3 probability. Calculate Neal's expected ROE, standard deviation, and coefficient of variation for each of the following debt-to-capital ratios. Do not round intermediate calculations. Round your answers to two decimal places. Debt/Capital ratio is 0. RÔE: O: CV: RÔE: Debt/Capital ratio is 10%, interest rate is 9%. RÔE: eBook O:…arrow_forward[EXCEL] Zero growth: Nynet, Inc., paid a dividend of $4.18 last year. The company's management does not expect to increase its dividend in the foreseeable future. If the required rate of return is 18.5 percent, what is the current value of the stock? Please use Excel.arrow_forward
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