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Corporrate Fina

ance Exxercise Seet #9

(Berk
k and DeMa
arzo - Chapters 15 - En
nd of Chapter Problem
ms)

*** Diiscussed in class


c on Deccember 6th ****

15-1. Pelam
med Pharmaceuticals has EBIT
E of $325 million in 20006. In additioon, Pelamed h
has interest exxpenses of
$125 million and a corporate tax
x rate of 40%..
a. What
W is Pelam
meds 2006 net income?
b. What
W is the tottal of Pelamed
ds 2006 net in
ncome and int erest paymentts?
c. If
I Pelamed had no interest expenses, wha
at would its 2 006 net incom
me be? How d
does it comparre to your
answer
a in partt b?
d. What
W is the am
mount of Pelam
meds interestt tax shield in 2006?

15-4. Braxtton Enterprises currently has


h debt outsta anding of $35 million and aan interest rate of 8%. Braxxton plans
to reduce its debt by repaying $7 million in n principal at the end of eeach year for the next fivee years. If
Braxttons margina al corporate ta
ax rate is 40%
%, what is the interest tax sh
hield from Brraxtons debt iin each of
the next five years?
?

15-5. Yourr firm currenttly has $100 million


m in debt outstandingg with a 10% interest rate. The terms off the loan
requiire the firm too repay $25 million of the balance each yeear. Suppose that the margginal corporatte tax rate
is 40%
%, and that the t interest ta ve the same riisk as the loaan. What is th
ax shields hav he present vallue of the
intereest tax shieldss from this deb
bt?

15-8. Bay Transport


T Sysstems (BTS) currently
c has $30
$ million in n debt outstanding. In addittion to 6.5% interest, it
planss to repay 5%
% of the remaiining balance each year. Iff BTS has a m marginal corp porate tax ratee of 40%,
and if
i the interest tax shields have
h the samee risk as the looan, what is tthe present vaalue of the in
nterest tax
shield
d from the debbt?

15-10. Rogoot Instrumentss makes fine violins


v and ceellos. It has $11 million in deebt outstandin
ng, equity vallued at $2
millio
on, and pays corporate
c inco
ome tax at a ra
ate of 35%. Itss cost of equitty is 12% and its cost of deb
bt is 7%.
a. What
W is Rogotts pretax WA
ACC?
b. What
W is Rogotts (effective affter-tax) WAC
CC?

15-14. Resteex maintains a debt-equity ratio of 0.85,, and has an equity cost off capital of 122%, and a debt cost of
capital of 7%. Resttexs corporatte tax rate is 40%,
4 and its m
market capitallization is $2200 million.
a. If
I Restexs freee cash flow is expected to o be $10 milllion in one yyear, what con
nstant expectted future
growth
g rate is consistent witth the firms current
c markeet value?
b. Estimate
E the value
v of Restex
xs interest tax
x shield.
15-18. Kurz Manufacturing is currently an all-equity firm with 20 million shares outstanding and a stock price of
$7.50 per share. Although investors currently expect Kurz to remain an all-equity firm, Kurz plans to
announce that it will borrow $50 million and use the funds to repurchase shares. Kurz will pay interest only
on this debt, and it has no further plans to increase or decrease the amount of debt. Kurz is subject to a 40%
corporate tax rate.
a. What is the market value of Kurzs existing assets before the announcement?
b. What is the market value of Kurzs assets (including any tax shields) just after the debt is issued, but
before the shares are repurchased?
c. What is Kurzs share price just before the share repurchase? How many shares will Kurz repurchase?
d. What are Kurzs market value balance sheet and share price after the share repurchase?

15-19. Rally, Inc., is an all-equity firm with assets worth $25 billion and 10 billion shares outstanding. Rally plans
to borrow $10 billion and use these funds to repurchase shares. The firms corporate tax rate is 35%, and
Rally plans to keep its outstanding debt equal to $10 billion permanently.
a. Without the increase in leverage, what would Rallys share price be?
b. Suppose Rally offers $2.75 per share to repurchase its shares. Would shareholders sell for this price?
c. Suppose Rally offers $3.00 per share, and shareholders tender their shares at this price. What will
Rallys share price be after the repurchase?
d. What is the lowest price Rally can offer and have shareholders tender their shares? What will its stock
price be after the share repurchase in that case?

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