a)
To determine: The value of levered firm VL and VUL.
a)
Explanation of Solution
Computation of value of levered firm VL and unlevered firm:
b)
To determine: The value of levered firm VL and VUL.
b)
Explanation of Solution
Computation of value of levered firm VL and unlevered firm:
c)
To determine: The value of levered firm VL and VUL.
c)
Explanation of Solution
Computation of value of levered firm VL and unlevered firm:
d)
To determine: The value of levered firm VL and VUL.
d)
Explanation of Solution
Computation of value of levered firm VL and unlevered firm:
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Chapter 17 Solutions
INTERMEDIATE FINANCIAL MANAGEMENT
- Companies U and L are identical in every respect except that U is unlevered while L has $20 million of 8% bonds outstanding. Assume: (1) All of the MM assumptions are met. (2) Both firms are subject to a 25% federal-plus-state corporate tax rate. (3) EBIT is $3 million. (4) The unlevered cost of equity is 12%. What is rs for Firm U?arrow_forwarda) Consider two firms L (Levered) & U (Unlevered) which are identical in all respect except for the capital structure. Both firms have EBIT of sh.900,000 ,a cost of equity of 10% and no corporate taxes. Firm L is partially using sh.4,000,000 of 7.5% interest debt while firm U is all equity financed. All the other traditional assumptions are applicable.Required:i) Using the Net income approach, compute the values of the two firms and WACC ii) Determine whether any of the two firms is overvalued giving an opportunity to make arbitrage profitiii) When would the arbitrage process cease?arrow_forwardChoose a,b,c,d,e for the following: Question 3 - Firm U has an EBIT of $10 million and is 100% equity-financed while Firm L, which also has an EBIT of $10 million, uses $100,000 as debt in its capital structure. The interest rate is 6% p.a. and both firms are subject to a 25% tax rate. Based on this information, which of the following is true? a. The value of Firm L is the same as the value of Firm U. b. The tax paid by Firm L is $2,500,000. c. The value of Firm L exceeds the value of Firm U by $1,500. d. Firm U pays lesser tax than Firm L. e. The cash flow from L is $7,501,500.arrow_forward
- Vimal Enterprises is considering a shipping project for which it proposes to employ a debt-equity ratio of 2:1. Its pre-tax cost of debt will be 12 percent and its expected tax rate is 30 percent. There are three firms, Aay, Bee, and Cee engaged wholly in shipping. Their tax rate is 35 percent. Their equity betas and debt-equity ratios are as follows: Firm Equity Beta Debt-Equity Ratio Aay 1.4 2 Bee 1.2 1.8 Cee 1.1 1.5 (a) What is the average asset beta of the three firms Aay, Bee, and Cee? (b) What is the beta of the equity for the shipping project of Vimal Enterprises ?arrow_forwarda) Consider two firms L (Levered) & U (Unlevered) which are identical in all respect except for the capital structure. Both firms have EBIT of sh.900,000 ,a cost of equity of 10% and no corporate taxes. Firm L is partially using sh.4,000,000 of 7.5% interest debt while firm U is all equity financed. All the other traditional assumptions are applicable.Required: Consider an investor who owns 10% of L’S Equity stock. He disposes the investment in L and borrows the amount equal to 10% of L’s debt and invests the entire proceeds in firm U. Show the investor’s income position. b) Consider the multifactor APT with two factors. The risk premiums on the factor 1 and factor 2 portfolios are 5% and 6%, respectively. Stock A has a beta of 1.2 on factor 1, and a beta of 0.7 on factor 2. The expected return on stock A is 17%. If no arbitrage opportunities exist, calculate the risk-free rate of return.arrow_forwardGive only typing answer with explanation and conclusion U and L are two firms with the same EBIT of $115,000. They are identical in every respect except firm L has a debt of $900,000 at 6% rate of interest. The cost of equity of firm U is 8% and that of firm L is 10%. Assume that arbitrage principle will be applied in this setting and it is possible to make an arbitrage profit (surplus). Also, all earnings streams are perpetuities, taxes are ignored and both firms distribute?arrow_forward
- Given: Firm A is all-equity financed and has total assets of $200 million. Firm B is an identical firm to Firm A, but 70% of its $200 million of total assets are financed with debt bearing an interest rate of 5%. Assume firms pay corporate taxes at the rate of 20% of taxable earnings. Both firms have the same EBIT, $15 million. Compute Firm B's interest deduction. Firm B’s interest deduction is $ ______ million. Keep the result with one decimal.arrow_forwardAntwerp Co. has a debt-to-equity ratio of 1.4, a corporate tax rate of 30%, pays 4% interest on its debt and has a required rate of return on equity of 12%. What is II’s WACC? How much does the debt tax shield reduce II’s WACC? What is the required rate of return on firm assets?arrow_forwardWhirlpool manufactures and sells home appliances under various brand names. IBM develops and manufactures computer hardware and offers related technology services. Target operates a chain of general merchandise discount retail stores. The data in the following table apply to these companies (dollar amounts in millions). For each firm, assume that the market value of the debt equals its book value. REQUIRED a. Assume that the intermediate-term yields on U.S. government Treasury securities are 3.5%. Assume that the market risk premium is 5.0%. Compute the cost of equity capital for each of the three companies. b. Compute the weighted-average cost of capital for each of the three companies. c. Compute the unlevered market (asset) beta for each of the three companies. d. Assume that each company is a candidate for a potential leveraged buyout. The buyers intend to implement a capital structure that has 75% debt (with a pretax borrowing cost of 8.0%) and 25% common equity. Project the weighted-average cost of capital for each company based on the new capital structure. To what extent do these revised weighted-average costs of capital differ from those computed in Requirement b?arrow_forward
- Assume that a company borrows at a cost of 0.08. Its tax rate is 0.35. What is the minimum after-tax cost of capital for a certain cash flow if a. 100 percent debt is used? b. 100 percent common stock? (assume that the stockholders will accept 0.08)arrow_forwardMM with Corporate Taxes Companies U and L are identical in every respect except that U is unlevered while L has $8 million of 5% bonds outstanding. Assume: (1) All of the MM assumptions are met. (2) Both firms are subject to a 25% federal-plus-state corporate tax rate. (3) EBIT is $4 million. (4) The unlevered cost of equity is 12%. a. What value would MM now estimate for each firm? (Hint: Use Proposition 1.) Enter your answers in millions. For example, an answer of $10,550,000 should be entered as 10.55. Round your answers to two decimal places. Company U: $ Company L: $ million million b. What is rs for Firm U? Round your answer to one decimal place. % What is rs for Firm L? Do not round intermediate calculations. Round your answer to one decimal place. % c. Find SL, and then show that SL + DV₁ results in the same value as obtained in Part a. Enter your answers in millions. For example, an answer of $10,550,000 should be entered as 10.55. Do not round intermediate calculations. Round…arrow_forwardYou have the following information about two firms, Debt Free, Incorporated and Debt Spree, Incorporated. Both firms have the same prospects for sales and EBIT, and both have the same level of assets, tax rate and borrowing rate. They differ in their use of debt financing. Scenario Sales Bad year $ 200 EBIT $ 28 Normal year $ 275 $ 36 Good year $ 380 $ 52 Total assets Tax rate Debt Equity Borrowing rate Debt Free $ 250 Debt Spree 21% $ 250 21% $ 0 $ 250 $ 150 $ 100 16% 16% Required: a. Calculate the interest expense for each firm: Interest expense for Debt Free Interest expense for Debt Spree b. Calculate the following items for each firm for each scenario (bad year, normal year, good year): return on assets (ROA), net profit, and return on equity (ROE). (Use a minus sign to indicate negative answers. Round your answers to 2 decimal places.) Scenario Bad year Normal year Good year ROA Debt Free Net Profit Debt Spree ROE ROA Net Profit ROE % % % % % % % % % % %arrow_forward
- Intermediate Financial Management (MindTap Course...FinanceISBN:9781337395083Author:Eugene F. Brigham, Phillip R. DavesPublisher:Cengage LearningFinancial Reporting, Financial Statement Analysis...FinanceISBN:9781285190907Author:James M. Wahlen, Stephen P. Baginski, Mark BradshawPublisher:Cengage LearningEBK CONTEMPORARY FINANCIAL MANAGEMENTFinanceISBN:9781337514835Author:MOYERPublisher:CENGAGE LEARNING - CONSIGNMENT