Financial Statements, Cash Flow, and Taxes - Solutions6

# Financial Statements, Cash Flow, and Taxes - Solutions6 - A...

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Old Exam Questions - Financial Statements, Cash Flow, and Taxes - Solutions Page 51 of 73 Pages A. \$6,000 B. \$4,000 C. \$7,000 D. \$5,000 * E. \$3,000 MVA = NPV = \$24,000 = (FCF / WACC) - Original Cost MVA = NPV = \$24,000 = (\$28,000 / WACC) - \$200,000 WACC = \$28,000 / (\$24,000 + \$200,000) = 12.50% EVA = NOPAT - (Capital)*(WACC) = \$28,000 - (\$200,000)*(.125) = \$3,000 MVA = NPV = EVA / WACC = \$3,000 / .125 = \$24,000 50. Now, instead of the WACC calculated above, assume that the firm initially raises the \$200,000 of capital by issuing \$100,000 of debt at a before-tax cost of debt (r D ) of 5.0% (the tax rate is 40%), and \$100,000 of equity at a cost of stock (r S ) of 13.0%: you should now be able to calculate the WACC (which may not be the same as in the problem above), the enterprise value, and the new market value of the firm’s equity. Given this market value, and assuming that the firm does not rebalance back to a 50/50 debt equity ratio, but that WACC does remain at its original level, determine what the new, implied cost of equity must be (HINT1: you can not unlever and relever beta for this problem; you must use the logic that we discussed and demonstrated in class. HINT2: work backwards from NOPAT to determine what EBIT must be, and then work forward to determine, and look at the value of, interest payments versus dividend payments.) A. 9.64% B. 9.28% C. 9.82% * D. 10.00% E. 9.46% WACC = (0.05)*(1-.40)*(50%) + (0.13)*(50%) = 1.50% + 6.50% = 8.0% Enterprise Value (EV) = \$28,000 / .08 = \$350,000 MV Equity = Enterprise Value - Debt = \$350,000 - \$100,000 = \$250,000 EBIT = NOPAT / (1-T) = \$28,000 / (1 - .40) = \$46,666.67 EBIT \$46,666.67 Interest - \$ 5,000.00 / .05 = \$100,000 (MV of Debt at r D = 5.0%) EBT \$41,666.67 Taxes - \$16,666.67 Net Income \$25,000.00 / 0.10 = \$250,000 (MV of Equity at r S = 10.0%)

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Page 52 of 73 Pages Enterprise Value \$350,000 Therefore, the implied r S is 10.00% Alternatively, New W D = \$100,000 / \$350,000 = 28.57% New W S = \$250,000 / \$350,000 = 71.43% but WACC remains at 8.0% Therefore, 8.0% = (0.05)*(1-.40)*(28.57%) + (r S )*(71.43%) r S = (8.0% - 0.857%) / (.7143) = 7.143 / 0.7143 = 10.0% __________ As we showed in class, if we rebalance so that Debt = \$175,000 (50%) and Equity = \$175,000(50%) then New Interest = (\$175,000)*(.05) = \$8,750 EBIT \$46,666.67 Interest - \$ 8,750.00 / .05 = \$175,000 EBT \$37,916.67 Taxes - \$15,166.67 Net Income \$22,750.00 / 0.13 = \$175,000 And we are back to a cost of stock, r S , of 13.0% 51. Assume that you and your significant other each had total ordinary taxable income of \$75,800 (assume no capital gains or dividend income) and calculated your taxes using the 2007 Single Tax Rates. Using the 2007 Tax Tables in the exam handout, determine the amount of the marriage penalty if you had files jointly using the 2007 Married Tax Rates. A.
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Financial Statements, Cash Flow, and Taxes - Solutions6 - A...

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