Lecture6 - GM apv question

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Unformatted text preview: 5 yrs,14%) = [1­1/(1.1415)]/.14 = 6.1422 NPV(FC) = ­800 + (800/15)x.34x6.1422 = ­$688.6 15 Regular Bond – Interest Tax Shields Two ways to compute: NPV(RB) = + 40,000 – 40,000x.14x(1­.34)x6.1422 ­ 40,000/1.1415 = $11,694.7 OR NPV(RB) = + 40,000x.14x.34x6.1422 = $11,694.7 16 Regular Bond – Total Financing Effect NPV of flotation costs = ­$688.6 NPV of interest tax shields = + $11,694.7 Total NPV of regular bond = + $11,006.1 17 Government-Sponsored Bond The interest rate on the bond is 8%, less than the market rate for govt. bonds with similar characteristics (10%). This bond carries both interest tax shields and a subsidy. A(10 yrs,10%) = [1­1/(1.1010)]/.1 = 6.1446 NPV of govt. sponsored bond = + 20,000 – 20,000x.08x(1­.34)x6.1446 ­ 20,000/1.1010 = $5,800.5 Note that you can’t compute it as before: = + 20,000x.08x.34x6.1446 = $3,342.7 < $5,800.5 Why is this last calculation wrong?? 18 Increase in Financial Distress Costs % of Aa1 firms that enter distress: 6% % of A1 firms that enter distress: 7% Increase in probability of financial distress: 1% Cost of financial distress: 5% of total market value Chrysler’s market value of assets: $10 million Increase in FDC = (.07­.06)x.05x$10,000,000 = $5,000.0 19 Total Financing Side Eff...
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