Fin516 Wk2 Hw S0Lutions

FI-516 – WEEK 2 – HOMEWORK ANSWER KEY

Problem 15–9

15-9 a. Present situation (50% debt):

WACC = wd rd(1-T) + wcers

= (0.5)(10%)(1-0.15) + (0.5)(14%) = 11.25%.

V = = $100 million.

70 percent debt:

WACC = wd rd(1-T) + wcers

= (0.7)(12%)(1-0.15) + (0.3)(16%) = 11.94%.

V = = $94.255 million.

30 percent debt:

WACC = wd rd(1-T) + wcers

= (0.3)(8%)(1-0.15) + (0.7)(13%) = 11.14%.

V = = $101.023 million.

Problem 15–10

15-10 a. BEA’s unlevered beta is bU=b/(1+ (1-T)(D/S))=1.0/(1+(1-0.40)(20/80)) = 0.870.

b. b = bU (1 + (1-T)(D/S)).

At 40 percent debt: bL = 0.87 (1 + 0.6(40%/60%)) = 1.218.

rS = 6 + 1.218(4) = 10.872%

c. WACC = wd rd(1-T) + wcers

= (0.4)(9%)(1-0.4) + (0.6)(10.872%) = 8.683%.

V = = $103.188 million.

Problem 26–8

26-8 a. VU = $500,000/(rsU – g) = $500,000/(0.13 - 0.09) = 12,500,000.

b.

So since D = 5, then S = 16 – 5 = $11.0 million.

= 15.7%

c. Under MM, VL = VU + TD = $12.5 million + (0.40)(5 million) = $14.5 million.

S = $14.5 – 5 = $9.5 million. rsL = 0.13+(0.13-0.07)(1-.40)(5/9.5) = 14.9%

d. VL is greater under the extension that incorporates growth than under MM because MM assumes 0 growth. A positive growth rate gives a larger value to the tax shield. In this case. the value of the tax shield under MM is 2.0 million and is $3.5 million if growth is included. The cost of capital when growth is included is higher because the relative weight of equity is higher and the relative weight of debt is lower than when...