Question 1:
Book Market
Net working capital=20 40=debt Net working capital=20 40=debt
Long-Term assets=80 60=equity Long-Term Assets=140 120=equity
100 100 160 160
Assume that MM's theory holds with taxes. There is no growth, and the $40 of debt is expected to be permanent. Assume a 40% corporate tax rate.
a. How much of the firm's value is accounted for by the debt-generated tax shield?
b. How much better off will UF's a shareholder be if the firm borrows $20 more and uses it to repurchase stock?
Question 2:
Calculate the weighted-average cost of capital (WACC) for Federated Junkyards of America, using the following information:
- Debt: $75,000,000 book value outstanding. The debt is trading at 90% of book value. The yield to maturity is 9%.
- Equity: 2,500,000 shares selling at $42 per share. Assume the expected rate of return on Federated's stock is 18%.
- Taxes: Federated's marginal tax rate is Tc = .35.
Question 3:
A project costs $1 million and has a base-case NPV of exactly zero (NPV = 0). What is the project's APV in the following cases?
a. If the firm invests, it has to raise $500,000 by a stock issue. Issue costs are 15% of net proceeds.
b. If the firm invests, its debt capacity increases by $500,000. The present value of interest tax shields on this debt is $76,000.