Ch 16 B8_Correct

Ch 16 B8_Correct - Alternatively, rearranging Equation...

Info iconThis preview shows pages 1–2. Sign up to view the full content.

View Full Document Right Arrow Icon
Chapter 16- B8. Dick’s Pet-Way Corporation is a Chain of pet stores that has an expected cash inflow of $2,160 each year forever. DPC’s (after-tax) required return is 18% per year. All cash flow streams in this problem are perpetuities, and all of DPC’s income is paid out to the firm’s investors. a) If DPC’s corporate tax rate is 35%, it is all-equity financed and there are no personal taxes, what is DPC worth (after taxes) in an otherwise-perfect capital market? b) Suppose DPC borrows $4,000 at a debt rate of 12%. What will DPC be worth in an otherwise perfect capital market? c) What will DPC’s WACC be after it borrows the $4,000 (in part b)? d) What will be the required return on DPC’s equity after it borrows the $4,000? Book Solution: B8. a. V U = I (1 - T)/r = 2,160 (1 - 0.35)/0.18 = 1,404/0.18 = $7,800 b. V L = V U + T D = $7,800 + 0.35 x 4,000 = $9,200 c. L = D/V L = 4,000/9,200 = 0.4383; and WACC = r(1 – TL) = 0.18(1 - 0.35x0.4383) = 15.2609%
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Background image of page 2
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: Alternatively, rearranging Equation 16.3, WACC = 1,404/9,200 = 15.2609% d. Rearranging WACC = (1 - L)r e + L(1 - T)r d , which is Equation 16.1, we have r e = (WACC - L(1 - T)r d )/(1 - L) = (15.2609% - 0.4383(1 - .35)12%)/(1 - .4383) = 21.08% (a more precise answer is 21.00% if you avoid rounding error) Correct Solution : a. V U = I (1 - T)/r = 2,160 (1 - 0.35)/0.18 = 1,404/0.18 = $7,800 b. V L = V U + T D = $7,800 + 0.35 x 4,000 = $9,200 c. L = D/V L = 4,000/9,200 = 0.43478; and WACC = r(1 TL) = 0.18(1 - 0.35x0.43478) = 15.2609% Alternatively, rearranging Equation 16.3, WACC = 1,404/9,200 = 15.2609% d. Rearranging WACC = (1 - L)r e + L(1 - T)r d , which is Equation 16.1, we have r e = (WACC - L(1 - T)r d )/(1 - L) = (15.2609% - 0.43478(1 - .35)12%)/(1 - .43478) = 21.000% 4000/9200 does NOT equal .4383, it equals .43478. When using the CORRECT weights, the answer will equal 21.000%, not 21.08%....
View Full Document

Page1 / 2

Ch 16 B8_Correct - Alternatively, rearranging Equation...

This preview shows document pages 1 - 2. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online