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CHAPTER 19

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Unformatted text preview: s original analysis and considering only corporate taxes, we have: r* = r (1 – TC L) r* = 0.147 ´ [1 – (0.35 ´ 0.55)] = 0.1187 or approximately 12% This matches the consultant’s estimate for the weighted­average cost of capital. 15. Disagree. The Banker’s Tryst calculations are based on the assumption that the cost of debt will remain constant, and that the cost of equity capital will not change even though the firm’s financial structure has changed. The former assumption is appropriate while the latter is not. 16. Tax or financing side effects in international projects: Project financing issues, such as early cash flows going to debt service resulting in a non­constant debt ratio. Subsidized financing rates. Guaranteed contracts for output. Government restrictions on the flow of funds. 17. a. Y ear 1 2 3 4 5 6 7 8 9 10 Principal at Start of Year 5000.0 4602.5 4185.1 3746.9 3286.7 2803.5 2296.2 1763.5 1204.2 616.9 Therefore: Principal Repayment 397.5 417.4 438.2 460.2 483.2 507.3 532.7 559.3 587.3 616.9 Interest 250.0 230.1 209.3 187.3 164.3 140.2 114.8 88.2 60.2 30.8 Interest Less Tax 162.5 149.6 136.0 121.7 106.8 91.1 74.6 57.3 39.1 20.0 Net Cash F l ow On Loan 560.0 567.0 574.2 581.9 590.0 598.4 607.3 616.6 626.4 636.9 Value of subsidy = \$5,000,000 ­ \$4,530,000 = \$470,000 b. Yes. The value of the subsidy measures the additional value to the firm from a government loan at 5 percent, compared to an unsubsidized loan at 10 percent. Therefore, the company should calculate APV, including PV (tax shields) on the unsubsidized loan, and then add in the value of subsidy. 18. a. Assume that the expected future Treasury­bill rate is equal to the 20­year Treasury bond rate (5.8%) less the average historical premium of Treasury bonds over Treasury bills (1.8%), so that the risk­free rate (rf) is 4%. Also assume that the market risk premium (rm – rf) is 8%. Then, using the CAPM, we find rE as follows: rE = rf + bA ´ [rm ­ rf] = 4% + (0.66 ´8%) = 9.28% Market value of e...
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