UGBA103_Pb_Set7_Solutions

UGBA103_Pb_Set7_Solutions - UGBA 103 Problem Set#7 GSI...

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UGBA 103 – Problem Set #7 GSI: Florent Rouxelin 15-1. Pelamed Pharmaceuticals has EBIT of \$325 million in 2006. In addition, Pelamed has interest expenses of \$125 million and a corporate tax rate of 40%. a. What is Pelamed’s 2006 net income? b. What is the total of Pelamed’s 2006 net income and interest payments? c. If Pelamed had no interest expenses, what would its 2006 net income be? How does it compare to your answer in part (b)? d. What is the amount of Pelamed’s interest tax shield in 2006? a. Net Income EBIT Interest Taxes 325 125 1 0.40 \$120 million. b. Net income + Interest = 120 + 125 = \$245 million c. Net income EBIT Taxes 325 1 0.40 \$195 million. This is 245 195 \$50 million lower than part (b). d. Interest tax shield 125 40% \$50 million 15-2. Grommit Engineering expects to have net income next year of \$20.75 million and free cash flow of \$22.15 million. Grommit’s marginal corporate tax rate is 35%. a. If Grommit increases leverage so that its interest expense rises by \$1 million, how will its net income change? b. For the same increase in interest expense, how will free cash flow change? a. Net income will fall by the after-tax interest expense to \$20.750 1 1 0.35 \$20.10 million. b. Free cash flow is not affected by interest expenses. 15-3. Suppose the corporate tax rate is 40%. Consider a firm that earns \$1000 before interest and taxes each year with no risk. The firm’s capital expenditures equal its depreciation expenses each year, and it will have no changes to its net working capital. The risk-free interest rate is 5%. a.

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UGBA103_Pb_Set7_Solutions - UGBA 103 Problem Set#7 GSI...

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