C09final_W2013_solution.pdf - ANSWER 1 a 2 2 1 EBIT Interest EBT Taxes 40 Net Income Stockholders Dividends Taxes 28 Bondholders Interest Taxes 28 All

C09final_W2013_solution.pdf - ANSWER 1 a 2 2 1 EBIT...

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ANSWER 1: All Equity Equity + Debt a. EBIT \$2,000,000 \$2,000,000 Interest 0 600,000 EBT \$2,000,000 \$1,400,000 2 Taxes @ 40% 800,000 560,000 Net Income \$1,200,000 \$840,000 All Equity Equity + Debt 2 Stockholders Dividends \$1,200,000 \$840,000 Taxes @ 28% 336,000 235,200 \$864,000 \$604,800 1 Bondholders Interest 0 \$600,000 Taxes @ 28% 168,000 0 \$432,000 1 Total to all investors \$864,000 \$1,036,800 1 Under MM without personal taxes we know that debt increased the cash flows to all investors. Since interest and dividends are taxed at the same personal rate, personal taxes only reduce the final cash flows to the investors. Personal taxes do not alter the conclusion that debt increases the value of the firm. b. All Equity Plan: Shareholders required rate of return after personal taxes 10%(1-0.28) = 7.2% 2 0 ) 1 )( 1 ( r T T EBIT V s c u = 2,000,000(1 0.4)(1 0.28) \$864,000 \$12,000,000 0.072 0.072 Equity + Debt Plan: (1 )(1 ) 1 (1 ) c s L u B T T V V T 2 (1 0.4)(1 0.28) \$12,000,000 1 10,000,000 (1 0.28) = \$12,000,000 + 4,000,000 = \$16,000,000
c. All Equity Equity + Debt 2 Stockholders Dividends \$1,200,000 \$840,000 Taxes @ 20% 240,000 168,000 \$960,000 \$672,000 2 Bondholders Interest 0 \$600,000 Taxes @ 32% 192,000 0 \$408,000 1 Total to all investors \$960,000 \$1,080,000 All Equity Plan: Shareholders required rate of return after personal taxes 10%(1-0.20) = 8% 2 0 ) 1 )( 1 ( r T T EBIT V s c u = 2,000,000(1 0.4)(1 0.20) \$960,000 \$12,000,000 0.08 0.08 Equity + Debt Plan: (1 )(1 ) 1 (1 ) c s L u B T T V V T

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