# Using the data given in part b but now assuming that

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Chapter 16 / Exercise 16-4
Intermediate Financial Management
Brigham/Daves
Expert Verified
Using the data given in Part b, but now assuming that Firms L and U are both subject to a 40 percent corporate tax rate, repeat the analysis called for in b(1) and b(2) under the MM with-tax model Value of levered firm is the unlevered value plus the debt tax shield: V L = V U + TD r sL = r sU + (r sU - r d )(1-T)(D/S) r d r s r sL = r sU + (r sU - r d )(1-T)(D/S) Value of Stock = (EBIT - r d D)(1 - T)/r S 0.00% 20.00% 40.00% 60.00% 0.00% 5.00% 10.00% 15.00% 20.00% 25.00% Without Taxes rs WACC rd Debt/Value Ratio Cost of Capital A B C D E F G H I 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 100 101 102 103 104 105 106 107 108 109 110 111 112 113 114 115
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Chapter 16 / Exercise 16-4
Intermediate Financial Management
Brigham/Daves
Expert Verified
\$0 \$0 \$0 \$400,000 Value of Tax Shield = T x Debt \$3,571,429 \$3,571,429 \$2,142,857 \$2,542,857 Value of Firm = Value of Unlevered Fi WACC 14.00% 14.00% 14.00% 11.80% Effects of Leverage: MM Models MM with Corporate Taxes 40.00% D V S D/V WACC 0.0 \$2.14 \$2.14 0.00% 8.00% 4.80% 14.00% 14.00% 0.5 \$2.34 \$1.84 21.37% 8.00% 4.80% 14.98% 12.80% 1.0 \$2.54 \$1.54 39.37% 8.00% 4.80% 16.34% 11.80% 1.5 \$2.74 \$1.24 54.74% 8.00% 4.80% 18.35% 10.93% 2.0 \$2.94 \$0.94 68.03% 8.00% 4.80% 21.66% 10.19% 2.5 \$3.14 \$0.64 79.62% 8.00% 4.80% 28.06% 9.54% 3.0 \$3.34 \$0.34 89.82% 8.00% 4.80% 45.76% 8.97% 3.5 \$3.54 \$0.04 98.87% 8.00% 4.80% 329.00% 8.46% V-No Taxes V-Taxes \$3.50 \$3.50 \$3.50 \$3.70 \$3.50 \$3.90 \$3.50 \$4.10 \$3.50 \$4.30 Value of Tax Shield Total Market Value of Firm WACC = (D/V)r d (1-T) + (S/V)r s T c = r d r d x (1-T) r s 0.00% 20.00% 40.00% 60.00% 80.00% 100.00% 0.00% 5.00% 10.00% 15.00% 20.00% 25.00% 30.00% 35.00% 40.00% 45.00% 50.00% With Taxes rs WACC rd x (1-T) Debt/Value Ratio Cost of Capital \$0.00 \$0.50 \$1.00 \$1.50 \$2.00 \$2.50 \$3.00 \$3.50 \$4.00 \$4.50 \$5.00 Relationship Between Value and Debt Without Taxes With Taxes Debt Value of Firm A B C D E F G H I 116 117 118 119 120 121 122 123 124 125 126 127 128 129 130 131 132 133 134 135 136 137 138 139 140 141 142 143 144 145 146 147 148 149 150 151 152 153 154 155 156 157 158 159 160 161 162 163 164 165 166 167 168 169 170 171 172 173
(1.) What is the gain from leverage according to the Miller model? (2.) How does this gain compare to the gain in the MM model with corporate taxes? d. Now suppose investors are subject to the following tax rates: T d = 30% and T s = 12%. Relevant information from part c. EBIT 500,000 Tax rate 40% Unlevered cost of equity 14% = WACC if there is no debt Cost of debt 8% Additional information Required reinvestment 50,000 growth rate 7% FCF Calculation NOPAT = EBIT x (1-T) NOPAT = 500,000 x 60% NOPAT = 300,000 FCF--7% growth = NOPAT - Required net reinvestment at 7% growth FCF--7% growth = 300,000 - 50,000 FCF--7% growth = 250,000 FCF -- 0% growth = NOPAT FCF -- 0% growth = 300,000 Firm U Firm U Firm L Firm L Data for 40% Tax Rate 40% Tax Rate 40% Tax Rate 40% Tax Rate Lyons zero Debt zero Debt some Debt some Debt and no growth and 7% growth and no growth and 7% growth exp. FCF \$ 300,000 \$ 250,000 \$ 300,000 \$ 250,000 Debt \$ - ### \$ 1,000,000 \$ 1,000,000 8.0% 8.0% 8.0% 8.0% 14.00% 14.00% 14.00% 14.00% Tax Rate 40% 40% 40% 40% growth 0% 7% 0% 7% Value of Unlev. Firm \$2,142,857 \$3,571,429 \$2,142,857 \$3,571,429 Value of Unlevered firm = FCF/(WAC Value of Tax Shield \$0 \$0 \$228,571 \$457,143 Total Value Of Firm \$2,142,857 \$3,571,429 \$2,371,429 \$4,028,571 Value of Firm = Value of Unlevered Fi Value of (3.) What does the Miller model imply about the effect of corporate debt on the value of the firm, that is, how do personal taxes affect the situation? Answer: See Chapter 15 Mini Case Show