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 pretax 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 nondiscretionary 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 allequity financed firm, the cost of capital is equal to the cost of equity.
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 Spring '11
 Kroger
 Finance, Economics, Debt

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