FIN 620 Session 7 Homework Assignment Answers

FIN 620 Session 7 Homework Assignment Answers - FIN 620...

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FIN 620 Session 7 Homework Assignment Answers: Session 7: Do problems 18-4, 18-12, 20-4, 20-14, and 21-14 18-4. a. In order to determine the cost of the firm’s debt, we need to find the yield to maturity on its current bonds. With semiannual coupon payments, the yield to maturity in the company’s bonds is: \$975 = \$40(PVIFA R% ,40 ) + \$1,000(PVIF R% ,40 ) R = .0413 or 4.13% Since the coupon payments are semiannual, the YTM on the bonds is: YTM = 4.13%× 2 YTM = 8.26% b. We can use the Capital Asset Pricing Model to find the return on unlevered equity. According to the Capital Asset Pricing Model: R 0 = R F + β Unlevered (R M – R F ) R 0 = 5% + 1.1(12% – 5%) R 0 = 12.70% Now we can find the cost of levered equity. According to Modigliani-Miller Proposition II with corporate taxes R S = R 0 + (B/S)(R 0 – R B )(1 – t C ) R S = .1270 + (.40)(.1270 – .0826)(1 – .34) R S = .1387 or 13.87% c. In a world with corporate taxes, a firm’s weighted average cost of capital is equal to: R WACC = [B / (B + S)](1 – t C )R B + [S / (B + S)]R S The problem does not provide either the debt-value ratio or equity-value ratio. However, the firm’s debt-equity ratio of is: B/S = 0.40 Solving for B:

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B = 0.4S Substituting this in the debt-value ratio, we get: B/V = .4S / (.4S + S) B/V = .4 / 1.4 B/V = .29 And the equity-value ratio is one minus the debt-value ratio, or: S/V = 1 – .29 S/V = .71 So, the WACC for the company is: R WACC = .29(1 – .34)(.0826) + .71(.1387) R WACC = .1147 or 11.47% 18-12. The adjusted present value of a project equals the net present value of the project under all-equity financing plus the net present value of any financing side effects. First, we need to calculate the unlevered cost of equity. According to Modigliani-Miller Proposition II with corporate taxes: R S = R 0 + (B/S)(R 0 – R B )(1 – t C ) .16 = R 0 + (0.50)(R 0 – 0.09)(1 – 0.40)
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FIN 620 Session 7 Homework Assignment Answers - FIN 620...

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