FIN 620 Session 7 Homework Assignment Answers:
Session 7: Do problems 184, 1812, 204, 2014, and 2114
184.
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 ModiglianiMiller 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 debtvalue ratio or equityvalue ratio. However, the
firm’s debtequity ratio of is:
B/S = 0.40
Solving for B:
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View Full DocumentB = 0.4S
Substituting this in the debtvalue ratio, we get:
B/V = .4S / (.4S + S)
B/V = .4 / 1.4
B/V = .29
And the equityvalue ratio is one minus the debtvalue 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%
1812.
The adjusted present value of a project equals the net present value of the project under allequity
financing plus the net present value of any financing side effects. First, we need to calculate the
unlevered cost of equity. According to ModiglianiMiller 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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 Fall '09
 Halstead
 Debt, Net Present Value, Weighted average cost of capital, Mathematical finance, Price per share, new shares, subscription price

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