Savers are taxed on the nominal interest payments they receive rather than on the real interest payments. Suppose the government shifted from taxing...
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Use a risk premium of 5.5 percent40 percent

and a tax rate of if none is specified.

1. Union Pacific Railroad reported net income of $770 million after interest expenses of $320 million in a recent financial year. (The corporate tax rate was 36 percent.) It reported depreciation of $960 million in that year, and capital spending was $1.2 billion. The firm also had $4 billion in debt outstanding on the books, was rated AA (carrying a yield to maturity of 8 percent), and was trading at par (up from $3.8 billion at the end of the previous year). The beta of the stock is 1.05, and there were 200 million shares outstanding (trading at $60 per share), with a book value of $5 billion. Union Pacific paid 40 percent of its earnings as dividends and working capital requirements are negligible. (The Treasury bond rate is 7 percent.)


a. Estimate the FCFF for the most recent financial year.


b. Estimate the value of the firm now.


c. Estimate the value of equity and the value per share now.


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7. Savers are taxed on the nominal interest payments they receive rather than on the real interest payments. Suppose the government shifted from taxing nominal interest payments to taxing only real interest payments. (that is, savers could subtract the inflation rate from the nominal interest rate they received and only pay taxes on the resulting real interest rate). Use a market for loanahle funds graph to analyze the effects of this change in tax policy. What happens to the equilibrium real interest rate and the equilibrium quantity of loanable funds? What happens to the quantity of savings and investment? (7 marks)

3. Effects of leasing on financial statements Aa Aa Leasing is often referred to as off-balance-sheet financing because of the way that the transaction is treated and reported in financial statements. According to the FASB-issued Statement 13, which of the following statements is true? Assets leased under financial or capital leases should be reported as fixed assets on the balance sheet. Leased assets should be reported as current assets on the balance sheet. The present value of all future lease payments should be reported as assets on the balance sheet. O The present value of all past lease payments should be reported as a liability on the balance sheet. Consider the following statement on capital leases: According to Statement 13, the payments on a financial lease should be treated as an operating expense and should not in any case affect a firm's true debt ratio. Is the preceding statement true or false? O True O False To consider the financial statement effects of leasing versus purchasing an asset, review the following case of Shoe Building Inc.

4. You run a regression of monthly returns of Mapco, an oil- and gas-producing firm, on the S&P 500 Index and come up with the following output for the period 1991 to 1995. Intercept of the regression = 0.340%. X-coefficient of the regression =0.68 Standard error of X-coefficient =0.2 R2=56.0% There are 16.00 million shares outstanding, and the current market price is $4.00/share. The firm has $22.00 million in debt outstanding. The firm has a tax rate of 38.00% percent. What would an investor in Mapco's stock require as a return, if the Treasury bond rate is 4.00% percent? Use 7.00% as the market risk premium. Assume now that Mapco has three divisions. It plans to divest itself of one of the divisions for $14.00 million in cash and acquire another for $52.00 million (it will borrow $38.00 million to complete this acquisition). The division it is divesting is in a business line where the average unlevered beta is 0.17, and the division it is acquiring is in a business line where the average unlevered beta is 0.72. What will the beta of Mapco be after this acquisition?

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