Q1)

Assuming perfect capital markets:

Firm Xanc has a market beta for their equity of 1.2 and currently has a D/E rat

io of 1.4. If you consider

changing the D/E ratio to 1.6 how does this change the firm

s equity beta (assume the beta of the debt is

0 when the D/E ratio is 1.4, but becomes 0.01 when the D/E ratio is 1.

6)

?

Also figure out the new

expected return of the equity if r

m

=.12 and r

f

=.04?

Q2) Bent Co. has FCF of 5 million per year which should grow 5% per year, the

expected return on equity

is 12% and r

D

=.06 and the firm has a D/E ratio of 0.7 with an appropriate tax rate of 3

7%. With the above

information, value what the company is worth without an interest tax shiel

d. Now, value the company

with a tax shield a

nd

explain how much value the interest tax shield adds.

Q3) You would like to estimate the weighted average cost of capital for a new

airline business. Based on

its industry asset beta, you have already estimated an unlevered cost of capital

for the firm of 9%.

However, the new business will be 25% debt financed, and you anticipate i

ts debt cost of capital will be

6%. If its corporate tax rate is 40%, solve the following:

A)

What is the equity cost of capital

B)

What is the WACC?

Q4) (this question is very hard! Try it but do not get upset if you

can

t figure it out, you will still get

credit)

BBJ has a debt-equity ratio of 0.2. Current stock price is $50 per share, wi

th 2.5 billion shares

outstanding. The firm has a equity beta of 0.5 and can borrow at 4.2%,

where the risk free rate is 4%.

Market expected return is 10% and their tax rate is 35%.

A)

This year expected cash flows are $6.0 billion dollars, in this case what gro

wth rate of free cash

flows is consistent with its current share price?

B)

BBJ thinks it can add debt without impacting a risk of distre

ss

or other costs. With a higher debt

to equity ratio of 0.5, borrowing costs will rise to 4.5%. If BBJ ann

ounces that it will raise its

debt

-equity ratio to 0.5, through a leveraged recap (buying back shares) solve for

the affect this

will have on their stock price.

Q5

Robo LLC has no debt and a beta of 1.50. Robo expects free cash flo

w of $25 million per year

forever. If Robo is considering a change: by issuing debt to buyback sto

ck to have a 30% debt-equity

ratio that it will maintain this ratio forever. With this change assume

Robo

s cost of debt capital will be

6.50% and their tax rate is 35%. If the expected market return is 11% and the

risk free rate is 5% answer

the following questions:

What is the equity cost of capital and the WACC before the change takes

place?

A)

What is the equity cost of capital and the WACC after the change takes p

lace?

B)

With the change what is the value of the tax shield?