Question
River Cruises is all-equity with 100,000 shares. It now proposes to issue $150,000 of debt at an interest rate of 10% and use the proceeds
River Cruises is all-equity with 100,000 shares. It now proposes to issue $150,000 of debt at an interest rate of 10% and use the proceeds to repurchase $15,000 shares at $10 per share. Profits before interest are expected to be $115,000.
a. what is the ratio of price to expected earning for River Cruises before it borrows the $150,000
correct answer: price-earnings ratio ------- 8.70
b. what is the ratio after is borrows?
correct answer: price-earnings ratio ------ ? (Please highlight answer)
2nd Part of question:
Here are book- and market-value balance sheets of the United Frypan Company (figures in $ millions):
Book-Value Balance Sheet | |||
Net Working Capital | $45 | Debt | $45 |
Long-Term Assets | 55 | Equity | 55 |
$100 | $100 |
Market-Value Balance Sheet | |||
Net Working Capital | $45 | Debt | $45 |
Long-Term Assets | 200 | Equity | 200 |
$245 | $245 |
Assume that MM's Theory holds except for taxes. There is no growth, and the $45 of debt is expected to be permanent. Assume a 21% corporate tax rate.
a. How much of the firm's value is accounted for by the debt-generated tax shield? (note: Enter your answer in million rounded to 2 decimal places)
b. What is the United Frypan's after-tax WACC if rDebt = 7.1% and rEquity = 15.9%? (note: Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)
c. Now supposed that congress passes a law that eliminated the deductibility of interest for tax purposes after a grace period of 5 years. What will be the new value of the firms, other things equal? Assume an 7.1% borrowing rate.note: (Do not round intermediate calculations. Enter your answer in million rounded to 2 decimal places.)
A. PV Tax Shield | $ | million |
B. WACC | % | |
C. New Value of the Firm | $ | million |
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started