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Financing and Valuations

Interest tax shield benefit: Legitron Corporation has $460 million of debt outstanding at an interest rate of 10 percent. If Legitron is subject to a 37 percent marginal tax rate, the amount of the tax shield on that debt for this year is $ .

(Round answer to nearest dollar. Omit $ sign in answer.)

M&M Proposition 1: Marx and Spender has a current WACC of 20 percent. If the cost of debt capital for the firm is 14 percent and the firm is currently financed with 44 percent debt, the current cost of equity capital for the firm is %. Assume that all the assumptions of Modigliani and Miller Proposition 1 hold.

(Round answer to two decimal places. Omit % sign in answer.)

M&M Proposition 1: The weighted average cost of capital for a firm (assuming all three Modigliani and Miller assumptions) is 16 percent. If the firm's cost of debt is 9 percent and the proportion of debt to total firm value for the firm is 0.5, the current cost of equity capital for the firm is %. Assume that all the assumptions of Modigliani and Miller Proposition 1 hold.

(Round answer to two decimal places. Omit % sign in answer.)

M&M Proposition 2: Backwards Resources has a WACC of 12.1 percent, and it is subject to a 35 percent marginal tax rate. Backwards has $293 million of debt outstanding at an interest rate of 12 percent and $612 million of equity (market value) outstanding. The expected return of the equity given this capital structure is %.

(Round answer to two decimal places. Omit % sign in answer. All intermittent calculations should be rounded to 4 decimal places before carrying to next calculation.)

Income approaches: You are using the FCFF approach to value a business. You have estimated that the FCFF for next year will be $123.65 million and that it will increase at a rate of 8 percent for each of the following three years. After that point, the FCFF will increase at a rate of 3 percent forever. If the WACC for this firm is 10 percent, the firm is worth $ millions.

(Enter value in millions, rounded to 2 decimal places.)

A friend of yours is trying to value the equity of a company and, knowing that you have read this book, has asked for your help. So far she has tried to use the FCFE approach. She estimated the cash flows to equity to be as follows:
Sales $800.0
-CGS -450.0
-Depreciation -80.0
-Interest -24.0
Earnings before taxes (EBT) 246.0
-Taxes (0.35 x EBT) -86.1
= Cash Flow to Equity $159.9

She also computed the cost of equity using CAPM as follows:
kE = kF + bE(Risk premium) = 0.06 + (1.25 x 0.084) = 0.165, or 16.5%

where the beta is estimated for a comparable publicly traded company. Using this cost of equity, she estimates the discount rate as

WACC = x_Debtk_Debt pretax(1 - t) + xcskcs

Based on this analysis, she concludes that the value of equity is $159.9 million/0.14 = $1,142 million.

Assuming that the numbers used in this analysis are all correct, what advice would you give your friend regarding her analysis?

Solution Preview

Interest tax shield benefit: Legitron Corporation has $460 million of debt outstanding at an interest rate of 10 percent. If Legitron is subject to a 37 percent marginal tax rate, the amount of the tax shield on that debt for this year is $ .

(Round answer to nearest dollar. Omit $ sign in answer.)
Show Work is REQUIRED for this question
M&M Proposition 1: Marx and Spender has a current WACC of 20 percent. If the cost of debt capital for the firm is 14 percent and the firm is currently financed with 44 percent debt, the current cost of equity capital for the firm is %. Assume that all the assumptions of Modigliani and Miller Proposition 1 hold.

(Round answer to two decimal places. Omit % sign in answer.)
Show Work is REQUIRED for this question
M&M Proposition 1: The weighted average cost of capital for a firm (assuming all three Modigliani and Miller assumptions) is 16 percent. If the firm's cost of debt is 9 percent and the proportion of debt to total firm value for the firm is 0.5, the current cost of equity capital for the firm is %. Assume that all the assumptions of Modigliani and Miller Proposition 1 hold.

(Round answer to two decimal places. Omit % sign in answer.)
Show Work is REQUIRED for this question
M&M Proposition 2: Backwards Resources has a WACC of 12.1 percent, and it is subject to a 35 percent marginal tax rate. Backwards has $293 million of debt outstanding at an interest rate of 12 percent and $612 million of ...

Solution Summary

Solution helps in discussing the weighted average cost of capital for a firm (assuming all three Modigliani and Miller assumptions) is 16 percent. If the firm's cost of debt is 9 percent and the proportion of debt to total firm value for the firm is 0.5, the current cost of equity capital for the firm is %. Assume that all the assumptions of Modigliani and Miller Proposition 1 hold.

$2.19