capstr1 - Capital Structure Choices Problem 1 a. Annual tax...

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Capital Structure Choices Problem 1 a. Annual tax savings from debt = $ 40 million * .09 * .35 = 1.26 $ b. PV of Savings assuming savings are permanent = $ 40 million * .35 = 14.00 $ c. PV of Savings assuming savings occur for 10 years = $ 1.26 (PVA,9%,10) = 8.09 $ d. PV of Savings will increase If savings are permanent = 1.26/.07 = 18.00 $ If savings are for 10 years = $1.26 (PVA,7%,10) = 8.85 $ Problem 2 a. After tax Interest Rate = 10% (1-.45) = 5.50% b. If only half the interest is allowed = 10% (1-.225) = 7.75% c. Yes. The tax savings will be much lower since the tax savings will not occur until three years from now. The after- tax interest rate will therefore be the same as the pre-tax rate (10%) for the first three years. Problem 3 a. Ignoring the net operating loss, PV of Tax Savings = $ 5 billion (.36) = 1.8 b. Yes. The net operating loss will mean that this tax savings will not occur for a while. For instance, if it will be 5 years before Westinghouse will have enough taxable income to claim the interest deduction, this $ 1.8 billion should be discounted back 5 years to arrive at the present value. Problem 4 a. False. There may be non-discretionary capital expenditures/working capital needs that drain cash flows. b. False. Capital expenditures may be discretionary. c. Partially true. The commitment to pay dividends is a much weaker one than the one to pay interest expenses. d. True. e. False. This is true only if management is not concerned about wealth maximization. Problem 5 a. Moderate. The low leverage may provide an opening. b. Moderate to High. The poor projects and the low leverage may make them susceptible; the poor earnings may act as impediment. c. Low. d. Low. e. Highest. Problem 6 a. Cost of Equity = 9% + 6% = 15% Since it is an all-equity financed firm, the cost of capital is equal to the cost of equity.
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This note was uploaded on 01/29/2012 for the course ECONOMICS 3400 taught by Professor Kroger during the Spring '11 term at Georgia State University, Atlanta.

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capstr1 - Capital Structure Choices Problem 1 a. Annual tax...

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