Capital Structure Problems

Capital Structure Problems

1. A company is considering a project that will be financed with debt and equity. The total
investment is $500,000, of which $200,000 is financed with debt with an annual interest rate of 10%.
The EBIT is $100,000 every year, in
perpetuity. The tax rate is 30% and the project’s WACC is 15%
p.a. Find the NPV of this project. (As we did in class, assume that depreciation equals
the investment
in fixed assets and other
non
–
operational cash flows.)
2. Why is it that all banks confor
m almost perfectly to the MM 1963 result, whereas most other
companies fall far short of the financing “recipe” implied by MM 1963.
Be brief.
3. The book value of a firm’s equity is $500,000, but the market value of equity is $700,000. The
firm’s debt has
a book and market value of $400,000. The corporate tax rate is 30% and the cost
of debt is 11%, whereas the cost of equity is 16%. Find the firm’s weighted average cost of
capital (WACC).
4. Explain why the market value of equity generally differs from i
ts book value.
Be specific and
brief.
5
. A company with $10 million in assets (book value) has just changed its capital structure from
D = $3 million to D = $5 million (these are both book and market values of debt). The corporate
tax rate is 30%. When it
had D = $3 million the market value of its equity was $8 million. Find
the market value of the equity now that the company has $5 million in debt.
6
. Wanton Soups, Inc. has a weighted average cost of capital (WACC) of 10.5 percent. The firm’s
cost of equ
ity is 15 percent, its tax rate is 40 percent, and its
market
debt
–
to
–
equity ratio (D/E) is
1.0. What is Wanton’s pre
–
tax cost of debt?
7. A project requiring an investment of $2 million is expected to generate an EBIT of $243,000
per year, forever. The equity por
tion of the investment is $1.3 million. The corporate tax rate is
30%, the annual cost of equity is 15%, and the annual cost of debt is 11%. Find the NPV of this
project using the two methods described in class; that is, using the traditional method and th
e
WACC method. (Notes: calculate the WACC as a percentage with 4 decimals (e.g., 12.1234%)
and assume, a
s we did in class, that depreciation equals
the investment in fixed assets and other
non
–
operational cash flows.)
8
. A project has an EVA of $4
million
and an NPV of $12 million. What is the project’s WACC?
9
.
The accounting statements of BuschBev, Inc. indicate that it had operating profits of $323
million last year,
that it
paid $53 million in financial expenses (i.e., interest), and
that it
paid $54
million in taxes.
The company had
$1.5 billion in assets,
and its WACC wa
s 10%. How much
EVA
did the company generate last year? NOTE: Assume
that BuschBev wa
s subject to the same
flat tax rate on all of its pre
–
tax earnings
.
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