FINC600 – Here are book- and market-value balance sheets of the United Frypan Company (UF)

| October 22, 2018

Complete the following
problems in either Microsoft Word or Excel.

Your work must be organized. Highlight
your final answer.

Chapter 14
14-2:
Here are book- and
market-value balance sheets of the United Frypan Company (UF):
Book Market
Net
Working Capital $20 $40
Debt Net Working Capital $20 $40 Debt
Long-term asset $80 $60 Equity Long-term
Assets $140 $120 Equity
$100 $100 $160 $160
(The
middle-of-the-road party was founded in 1961 by Miller and Modigliani, always
referred to as “MM”, when they published a proof that dividend policy is
irrelevant in a world without taxes, transaction costs, or other market
imperfections. MM argued as follows.
Suppose your firm has settled on its investment program. You have a plan to
finance the investments with cash on hand, additional borrowing, and
reinvestment of future earnings. Any surplus cash is to be paid out as
dividends.) 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 shareholders be if the firm borrows $20 more and uses it to
repurchase stock?

14-3:
What is the relative
tax advantage of corporate debt if the corporate tax rate is Tc = .35, the
personal tax rate is Tp = .35, but all equity income is received as capital
gains and escapes tax entirely (TpE = 0)? How does the relative tax advantage
change if the company decides to pay out all equity income as cash dividends
that are taxed at 15%?

Chapter 15
15-1:
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.

15-6:
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.

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