Capital structure-taxes and firm value

Assignment Help Financial Management

Reference no: EM131177482

Capital structure, taxes and firm value

Firm M will operate from time 0 to time 1, then shut down. At time 1, its EBIT will be 250. The tax rate on firm profits is 20%. The cost of capital is 25% for all cash flows regardless of risk.

a. First, assume that the firm is all equity financed. What is the firm value at time 0?

b. Next, assume that the firm repurchases 100 worth of stock. To finance this deal, the firm borrows 100 at time 0 and promises to pay back principal plus interest at time 1. The interest rate is equal to the required cost of capital. What is the total payoff (principal + interest) to the debt holders at time 1?

c. What is the payoff to the equity holders at time 1? What is the value of equity at time 0?

d. What is the present value of the tax shield of debt? Why is it not equal to the amount of debt times the tax rate as usual?

Reference no: EM131177482

Questions Cloud

Estimate the yield for this investment : Assume that an investor generates the following income stream and can be purchased at the beginning of 209 for $1000 and sold at the end of 2015 for $1200. Estimate the yield for this investment. If a minimum return of 9% is required, would you recom..

Reported earnings available to common stock : Edna Reporting Studios Inc, reported earnings available to common stock of $4,200,000 last year. From those earnings, the company paid dividends of $1.29 on each of each $1,000,000 common shares outstanding. If the market price of the common stock is..

Calculate the modified duration of the bond : Consider a bond with annual coupon rate = 7%, yield to maturity = 5%, time to maturity = 3 years, and face value = $200. Coupons are paid semiannually. Calculate the price of the bond. Calculate the modified duration of the bond. Calculate the convex..

What is the market rate of return on this stock : The common stock of Eddie's Engines, Inc. sells for $37.13 a share. The stock is expected to pay $3.10 per share next year. Eddie's has established a pattern of increasing their dividends by 5.2 percent annually and expects to continue doing so. What..

Capital structure-taxes and firm value : Firm M will operate from time 0 to time 1, then shut down. At time 1, its EBIT will be 250. The tax rate on firm profits is 20%. The cost of capital is 25% for all cash flows regardless of risk. First, assume that the firm is all equity financed. Wha..

Material purchase price variance-material quantity variance : Balderson Co. has a budgeted monthly capacity of 20,000 direct labor hours with a standard production of 10,000 units at that capacity. Determine the following variances. Material purchase price variance. Material price usage variance. Material quant..

What is your estimate of the stocks current price : A company currently pays a dividend of $2.25 per share (D0 = $2.25). It is estimated that the company's dividend will grow at a rate of 20% per year for the next 2 years, then at a constant rate of 6% thereafter. The company's stock has a beta of 1, ..

Shares of common stock outstanding : Erna Corp. has 6 million shares of common stock outstanding. The current share price is $72, and the book value per share is $7. Erna Corp. also has two bond issues outstanding. Suppose the most recent dividend was $4.40 and the dividend growth rate ..

Calculate european call price using the general equation : Consider a three-period (four-date) binomial model that has the following characteristics: • Current price for underlying stock S = $40, Exercise price X = $40 • In each period, the stock price goes up by 6% or down by 2% from what it was in the prev..

User Account

All Pages