Remaining investment worth e l 1 t cpn r l 1 66 016

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remaining investment worth: E L = (1 – T)( – CPN) / r L = (1 – 0.4)($150 – $40) / 0.16 = $66 / 0.16 = $412.50 for a total value of V L = D + E L = $500 + $412.50 = $912.50 . Thus, in this environment, the proposed leveraging increases shareholder value by: G L = V L – V U = $912.50 – $750 = $162.50 .] a 59. Assume the corporate tax view of capital structure. Your unleveraged cost of capital is 15%. Your leveraged cost of equity is 20% and your cost of debt is 10%. Your corporate tax rate is 37.5%. Your firm proposes to borrow $500 and its leveraged firm value is $812.50. What is your cost of capital under the proposed leveraging? a. 11.5385% b. 11.3077% c. 11.2399% d. 11.1282% [ ANSWER: Your leveraged capital structure would be L = D / (D + E) = $500 / $812.50 = 0.6153846. Your WACC = r(1 – [T(L)]) = 15%(1 – [0.375(0.6153846)]) = 15%(1 – 0.2307692) = 15%(0.7692307) = 11.538462% or about 11.5385% . NOTE. You can also use the equation: WACC = (1 – L)r e + L(1 – T)r d = (1 – 0.6153846)20% + 0.6153846(1 – 0.375)10% = 7.692308% + 3.846154 = 11.5385% .] c 60. Assume the corporate tax view of capital structure. Your unleveraged cost of capital is 13%. Your corporate tax rate is 30%. Your firm proposes to borrow $800 and its leveraged firm value is $1,600. What is your cost of capital under the proposed leveraging? a. 11.53% b. 11.33% c. 11.05% d. 10.94% [ ANSWER: Your leveraged capital structure would be L = D / (D + E) = $800 / $1,600 = 0.5. Your WACC = r(1 – [T(L)]) = 13%(1 – [0.3 (0.5)]) = 13%(1 – 0.15) = 13%(0.85) = 0.1105 or 11.05% .] c 61. Acme, Inc. is an all-equity firm. Its shareholders' personal tax rate (T e ) is 20%. Acme pays corporate taxes on its net income but otherwise operates in a perfect capital market environment. Acme has a perpetual expected cash inflow each year () of $150. Its corporate tax rate (T) is 37.5% and its unleveraged cost of capital (r) is 15%. What is Acme’s unleveraged value with both personal and corporate taxes considered? [ (1 – 0.2)(1 – 0.375)$150 / 0.15 = $75 / 0.15 = $500M .] c 62. Acme, Inc. is an all-equity firm. Its shareholders' personal tax rate (T e ) is 10%. Acme pays corporate taxes on its net income but otherwise operates in a perfect capital market environment. Acme has a perpetual expected cash inflow each year () of $15M (M = million). Its
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corporate tax rate (T) is 30% and its unleveraged cost of capital (r) is 12%. What is Acme’s unleveraged value with both personal and corporate taxes considered? [ (1 – 0.2)(1 – 0.3)$15M / 0.12 = $8.4M / 0.12 = $70M .] c 63. Acme, Inc. is an all-equity firm. Acme can issue debt to debtholders whose personal tax rate (T d ) is 50%. Its shareholders' personal tax rate (T e ) is 20%. Acme pays corporate taxes on its net income but otherwise operates in a perfect capital market environment. Acme has a perpetual expected cash inflow each year () of $150M (M = million). Its corporate tax rate (T) is 37.5% and its unleveraged cost of capital (r) is 15%. Now suppose the firm can borrows at a personal before-taxes required return (r d ) of 10%. If its before-tax payment (CPN) is $50M, how much money will Acme borrow on an after-tax basis? [ 0.1($250) / 0.1 = $250M .] c
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