answers-odd-problems-ch17

answers-odd-problems-ch17 - Chapter 17 Capital Structure...

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Chapter 17 Capital Structure Decisions: Extensions SOLUTIONS TO END-OF-CHAPTER PROBLEMS 17-1 a. b L = b U [1 + (1 - T)(D/S)]. b U = ) S / D )( T 1 ( 1 b L - + = ) 5 . 0 / 5 . 0 )( 4 . 0 1 ( 1 8 . 1 - + = 6 . 1 8 . 1 = 1.125. b. r sU = r RF + (r M - r RF )b U = 10% + (5%)1.125 = 10% + 5.625% = 15.625%. c. $2 Million Debt: V L = V U + TD = $10 + 0.25($2) = $10.5 million. r sL = r sU + (r sU - r RF )b U (1 - T)(D/S) = 15.625% + (15.625% - 10%)(0.75)($2/$8.5) = 15.625 + 5.625% (0.75)($2/$8.5) = 16.62%. $4 Million Debt: V L = $10 + 0.25($4) = $11.0 million. r sL = 15.625% + 5.625%(0.75)($4/$7) = 18.04%. $6 Million Debt: V L = $10 + 0.25($6) = $11.5 million. r sL = 15.625% + 5.625% (0.75)($6/$5.5) = 20.23%. d. $6 Million Debt: V L = $8.0 + 0.40($6) = $10.4 million. r sL = 15.625% + 5.625%(0.60)($6/$4.4) = 20.23%. The mathematics of MM result in the required return, and, thus, the same financial risk premium. However, the market value debt ratio has increased from $6/$11.5 = 52% to $6/$10.4 = 58% at the higher tax rate.
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answers-odd-problems-ch17 - Chapter 17 Capital Structure...

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