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Problem Set #5
Business Finance (03075 & 03085)
Please note that you do not have to submit your answers.
They will not be graded.
But,
similar questions will appear in the quiz.
Answer keys will be uploaded at Blackboard
soon.
1.
(
MM with Tax
) The market value of a firm with $500,000 of debt is $1.7 million.
The
pretax interest rate on debt is 10 percent per annum, and the company is in the 34
percent tax bracket.
The company expects $306,000 of earnings before interest and
taxes every year in perpetuity.
a.
(2 points) What would the value of the firm be if it were financed entirely with
equity? [
Hint
: use Proposition I of the MM Model with Tax]
b.
(2 point) What amount of the firm’s annual earnings is available to stockholders?
2.
(
MM with Tax
) The Holland Company expects perpetual earnings before interest and
taxes (EBIT) of $4 million per year.
The firm’s aftertax, allequity discount rate (r
0
)
is 15 percent.
Holland is subject to a corporate tax rate of 35 percent.
The pretax
cost of the firm’s debt capital is 10 percent per annum, and the firm has $10 million of
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 Fall '08
 Goldreyer
 Debt

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