Quiz 2_03085 Answers - Quiz #2 Finance 357 Business Finance...

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Quiz #2 Finance 357 Business Finance (03085) Last Name First Name UTEID 1. (2 points) Rayburn Manufacturing Inc. is currently an all-equity firm that pays no taxes. The market value of the firm’s equity is $3 million. The cost of this un-levered equity is 18 percent per annum. Rayburn plans to issue $500,000 in debt and use the proceeds to repurchase stock. The cost of debt is 10 percent per annum. a. After Rayburn repurchases the stock, what will the firm’s weighted average cost of capital be? Under MM assumptions, WACC = r 0 = 18 percent b. After the repurchase, what will the cost of equity be? Explain. S L = V L – B = $3 m - $0.5 m = $2.5 million r S = r 0 + (B/S L )(r 0 – r B ) = 18 + (0.5/2.5)(18-10) = 19.6 percent c. Use your answer to (b) to compute Rayburn’s weighted average cost of capital after the repurchase. Is this answer consistent with (a)? WACC = (B/V L ) r B + (S L /V L ) r S = (0.5/3)10 + (2.5/3)19.6 = 18 percent
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2. (2 points) The Holland Company expects perpetual earnings before interest and taxes (EBIT) of $5 million per year. The firm’s after-tax, all-equity discount rate (r 0 ) is 20 percent. Holland is subject to a corporate tax rate of 35 percent. The pretax cost of
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This note was uploaded on 02/23/2009 for the course FIN 374C taught by Professor Goldreyer during the Fall '08 term at University of Texas at Austin.

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Quiz 2_03085 Answers - Quiz #2 Finance 357 Business Finance...

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