show workings and formulas please.
Problem 3 (32 marks) Your best friend is in a senior position of the finance department of Teenie Tiny and you are having lunch together after a round at the golf course. The discussion gets around to the fact that Teenie Tiny will lose their tax-exempt status and your friend mentions that all the debt that the company needs will be financed using bonds with a 5 percent coupon. However, you remember that during a lecture at SMU, it was mentioned that as a company issues more and more debt, the risk for the bondholders will increase and bondholders will require coupon interest rates to increase as the amount of debt increases. You have prepared the following table to assist in answering these questions: Value of RD Beta Debt EBIT 800,0000 5.0% 1.392500 Tax 40% 250,000 5.5% 1.483015 Rate T- 3.0% 500,000 6.0% 1.542274 bill Rate TSX 11.0% 750,000 6.5% 1.607016 1,000,000 7.0% 1.678038 1,250,000 9.0% 1.756303 1,500,000 11.0% 1.842075 1,750,000 13.0% 1.939488 2,000,000 15.0% 2.047619 e. Calculate the present value of distress. (4 marks) Value of Debt PV of Value of Value of Distress the Firm the Firm World III - World III World II World II lo 250,000 500,000 750,000 1,000,000 1,250,000 1,500,000 1,750,000 2,000,000 f. Graph (on 2 separate graphs) the information for proposition I and proposition II. (4 marks) g. Briefly explain the amount of debt the company should use as a levered company. (2 marks) To maximize the value of the firm and to minimize the WACC for the firm, the unlevered firm should issue $1,000,000 of debt. Problem 3 (32 marks) Your best friend is in a senior position of the finance department of Teenie Tiny and you are having lunch together after a round at the golf course. The discussion gets around to the fact that Teenie Tiny will lose their tax-exempt status and your friend mentions that all the debt that the company needs will be financed using bonds with a 5 percent coupon. However, you remember that during a lecture at SMU, it was mentioned that as a company issues more and more debt, the risk for the bondholders will increase and bondholders will require coupon interest rates to increase as the amount of debt increases. You have prepared the following table to assist in answering these questions: Value of RD Beta Debt EBIT 800,0000 5.0% 1.392500 Tax 40% 250,000 5.5% 1.483015 Rate T- 3.0% 500,000 6.0% 1.542274 bill Rate TSX 11.0% 750,000 6.5% 1.607016 1,000,000 7.0% 1.678038 1,250,000 9.0% 1.756303 1,500,000 11.0% 1.842075 1,750,000 13.0% 1.939488 2,000,000 15.0% 2.047619 e. Calculate the present value of distress. (4 marks) Value of Debt PV of Value of Value of Distress the Firm the Firm World III - World III World II World II lo 250,000 500,000 750,000 1,000,000 1,250,000 1,500,000 1,750,000 2,000,000 f. Graph (on 2 separate graphs) the information for proposition I and proposition II. (4 marks) g. Briefly explain the amount of debt the company should use as a levered company. (2 marks) To maximize the value of the firm and to minimize the WACC for the firm, the unlevered firm should issue $1,000,000 of debt
