Masters level finance- need one problem solved- due Thursday 11/8

Hello,

 

I just need one problem answered. It’s just text answer. There isn’t any problem solving involved. The problem I need done is P14-24.

Question:

Some companies’ debt-equity targets are expressed not as a debt ratio, but as a target debt rating on a firm’s outstanding bonds. What are the pros and cons of setting a target rating, rather than a target ratio?

Instructions

NAME:

To complete the homework assignments in the templates provided:

1.

The question is provided for each problem. You may need to refer to your textbook for additional information in a few cases.

2.

You will enter the required information into the shaded cells.

3.

The cells are coded:

a.

T requires a text answer.

b.

C requires a calculation. You cannot perform the operation on a calculator and then type the answer in the cell. You will enter the calculation in the cell, and only the final answer will show in the cell. I will be able to review your calculation and correct, if necessary.

c.

F requires a number only. In some problems, a “Step 1” is added to help you solve the problem.

4.

Name your assignment file as “lastnamefirstinitial-FINC600-Week#”, and submit by midnight ET, Day 7.

&C&”Calibri,Regular”&16Instructions
&C&”Calibri,Regular”&11Principles of Corporate Finance, Concise, 2nd Edition

P14-2

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?

40%

a.

b.

Problem 14-2
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%
		Answer:
Step 1:
Tax rate – Tc
Permanent Debt – D	$40.00
Additional Debt – D	$20.00
Step 2:
Formula		Calculation
a. Tax shield	=Permanent debt x tax rate	$16.00
b. Tax shield	=(Permanent debt+Additional debt) x tax rate	$24.00
Benefit to Shareholders	$8.00	TIP: difference between a and b

&L&”Calibri,Regular”&11Instructions: Please refer to your book for assistance with your homework. Post your work in the worksheet. Highlight your final answer.
&C&”Calibri,Regular”&11Principles of Corporate Finance, Concise, 2nd Edition

P14-24

Answer:

Problem 14-24

Some companies’ debt-equity targets are expressed not as a debt ratio, but as a target debt rating on a firm’s outstanding bonds. What are the pros and cons of setting a target rating, rather than a target ratio?

Pros T

Cons T

&L&”Calibri,Regular”&11Instructions: Please refer to your book for assistance with your homework. Post your work in the worksheet. Highlight your final answer.

P15-6

Calculation
a.

b.

Problem 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.
Answers:
APV stock issue	= Base-case NPV + PV of financing effect
=0 + $1 Million + 500,000(1-15%)
$ 1,425,000
APV debt increases	= Base-case NPV + PV of financing effect + Interest tax shield
=0 + $1 Million – 500,000 + 76000
$ 576,000

&L&”Calibri,Regular”&11Instructions: Please refer to your book for assistance with your homework. Post your work in the worksheet. Highlight your final answer.
&C&”Calibri,Regular”&11Principles of Corporate Finance, Concise, 2nd Edition

P15-9

Answer:

Problem 15-9

The WACC formula seems to imply that debt is “cheaper” than equity–that is, that a firm with more debt could use a lower discount rate. Does this make sense? Explain briefly.

Capital structure represents the relative proportion of the different sources of funds of company. This includes debt, equity and hybrid instruments such as convertible bonds. As cost of equity is not explicitly displayed in income statement and cost of debt is itemized in the income statement, it is easy to forget that debt is cheaper source of funding than equity. Debt is cheaper than equity for two reasons; First, debtors have a prior claim if the company goes into liquidation or become bankrupt and therefore, warrants investors a lower rate of return for the company. Second, Interest paid is tax deductible and thus creates lower tax bill, effectively creates cash for the company. Weighted average cost of capital tells us the return that both equity stakeholders – equity owners and lenders – can expect from the company. It is the opportunity cost of taking on the risk of putting money into the company. For example if a firm has 60% debt and 40% equity and the required rate of return on debt is 10% whereas on equity is 20%. This means that the overall rate of return (Weighted average cost of capital) of a company is less than 15% ((10*60%)+(20*40%)/100%=14%). However, in case if we turn the scenario and now debt is 40% and equity is 60% then, the overall rate of return (Weighted average cost of capital) of a company is going to be greateer than 15% ((10*40%)+(20*60%)/100% = 16%)

&L&”Calibri,Regular”&11Instructions: Please refer to your book for assistance with your homework. Post your work in the worksheet. Highlight your final answer.