# 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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