18 the interest tax shield is a key reason why a the

This preview shows page 3 - 4 out of 4 pages.

18. The interest tax shield is a key reason why: (a) the required rate of return on assets rises when debt is added to the capital structure. (b) the value of an unlevered firm is equal to the value of a levered firm. (c) the net cost of debt to a firm is generally less than the cost of equity.
Page 3
(d) the cost of debt is equal to the cost of equity for a levered firm. 19. You own 25% of Unique Vacations, Inc. You have decided to retire and want to sell your shares in this closely held, all equity firm. The other shareholders have agreed to have the firm borrow $1.5 million to purchase your 1,000 shares of stock. What is the total value of this firm today if you ignore taxes?
20. The Backwoods Lumber Co. has a debt-equity ratio of .80. The firm’s required return on assets is 12% and its cost of equity is 15.68%. What is the pre-tax cost of debt based on MM Proposition II with no taxes?
Short Answers 30 Points 21. Cavo Corporation expects an EBIT of $19,750 every year forever. The company currently has no debt, and its cost of equity is 15 percent. (a) What is the current value of the company? (10 points) (b) Suppose the company can borrow at 10 percent. If the corporate tax rate is 35 percent, what will the value of the firm be if the company takes on debt equal to 50 percent of its unlevered value? (10 points) (c) What will the value of the firm be if the company takes on debt equal to 50 percent of its levered value? (10 points) Page 4

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture