Hi,

I have attached these questions and I hope to help me find their solution.

FINA3371 Exercise 3 Due Date: Dec 13 1. Interest Tax Shelter MVP Inc., a manufacturing firm with no debt outstanding and a market value of $100 million is considering borrowing $ 40 million and buying back stock. Assuming that the interest rate on the debt is 9% and that the firm faces a tax rate of 35%, answer the following questions: Required a. Estimate the annual interest tax savings each year from the debt. b. Estimate the present value of interest tax savings, assuming that the debt change is permanent. c. Estimate the present value of interest tax savings, assuming that the debt will be taken on for 10 years only. 2. Cost of Capital Capital Structure Rubberman Corporation, a manufacturer of consumer plastic products, is evaluating its capital structure. The balance sheet of the company is as follows (in millions): Assets Debt + Equity Fixed Assets 4000 Debt 2500 Current Assets 1000 Equity 2500 In addition, you are provided the following information: o o o o The debt is in the form of long term bonds, with a coupon rate of 10%. The bonds are currently rated AA and are selling at a yield of 12% (the market value of the bonds is 80% of the face value). The firm currently has 50 million shares outstanding, and the current market price is $80 per share. The firm pays a dividend of $4 per share and has a price/earnings ratio of 10. The stock currently has a beta of 1.2. The six-month Treasury bill rate is 8%. The tax rate for this firm is 40%. Required a. What is the debt/equity ratio for this firm? b. What is the debt/(debt+equity) ratio for this firm? c. What is the firm's after-tax cost of debt? d. What is the firm's cost of equity? FINA3371 Exercise 3 Due Date: Dec 13 e. What is the firm's current cost of capital? 3. Optimal Capital Structure (continuation of Rubberman Q.2) Rubberman is considering a major change in its capital structure. It has three options: Option 1: Issue $1 billion in new stock and repurchase half of its outstanding debt. This will make it a AAA rated firm (AAA rated debt is yielding 11% in the market place). Option 2: Issue $1 billion in new debt and buy back stock. This will drop its rating to A-. (Arated debt is yielding 13% in the market place). Option 3: Issue $3 billion in new debt and buy back stock. This will drop its rating to CCC (CCC rated debt is yielding 18% in the market place). Required a. What is the cost of equity under each option? b. What is the after-tax cost of debt under each option? Assume that the cost of all debt (old and new) changes under each scenario to the cost associated with the firms new rating. c. What is the cost of capital under each option? d. What would happen to o the value of the firm; o the value of debt and equity; and o the stock price under each option , if you assume rational stockholders? e. Which of the three options would you recommend, or would you stay at your current capital structure? Why? 4. EPS CB Corp. is considering two alternative capital structures. The conservative capital structure calls for a D/A ratio = 0.25, while the aggressive strategy calls for D/A = 0.75. Once the firm selects its target capital structure, it envisions two possible scenarios for its operations: Feast or Famine. The Feast scenario has a 60% probability of occurring and forecasted EBIT in this state is $60,000. The Famine state has a 40% chance of occurring and expected EBIT is $20,000. Further, if the firm selects the conservative capital structure its cost of debt will be 10%, while with the aggressive capital structure its debt cost will be 12%. The firm will have $400,000 in total assets, it will face a 40% marginal tax rate, and the book value of equity per share under either scenario is $10.00 per share. Required a. Compare the conservative capital structure to the aggressive capital structure on the basis of: FINA3371 Exercise 3 Due Date: Dec 13 a. Expected EPS b. Range of EPS (high / low) b. What is the breakeven expected EBIT