Problem_Set__6_Solutions

# Problem_Set_6_Solut - BusM 401 Problem Set#6 Capital Structure Solutions 1 Haverhill Corporation has net income of \$10 million per year on net

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BusM 401 Problem Set #6 Capital Structure Solutions 1. Haverhill Corporation has net income of \$10 million per year on net sales of \$100 million per year. It currently has no long-term debt, but is considering a debt issue of \$5 million. The interest rate on the debt would be 8%. Haverhill currently faces an effective tax rate of 35%. Assuming this debt is held in perpetuity, what would be the total value of the tax shield to Haverhill if it goes through with the debt issuance? tD = 0.35 X 5 million = \$1,750,000 2. Why does the debt overhang problem make it difficult for firms facing financial distress to finance projects with new equity? Investors will be reluctant to supply new equity to a company in financial distress because they recognize that the increased value from the project may go entirely to pay debtholders. 3. Do Higgins Chapter 6, #3. Answers provided in back of book. 4. Do Higgins, Chapter 6, #12. Do only parts a, b, c, f, g. (Studying past annual reports, as suggested in the problem, might be useful for part f, if you want to assess the volatility of Avon’s cash flow.) a. 2001 2002 2003 Shareholders’ equity (\$75) (\$128) \$371 Liabilities-to-assets ratio 1.02 1.04 0.90 Times-interest-earned ratio 10.7 15.0 21.3 The first two numbers suggest that Avon is highly levered, so levered that its liabilities exceed the accounting value of its assets in 2001 and 2002. The third number, on the

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## This note was uploaded on 02/22/2012 for the course BUS M 401 taught by Professor Toddmitton during the Winter '10 term at BYU.

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Problem_Set_6_Solut - BusM 401 Problem Set#6 Capital Structure Solutions 1 Haverhill Corporation has net income of \$10 million per year on net

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