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##### MBA570_Homework_7

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Question;Instructions: Either type or;write your answers directly on this document and submit the completed;assignment to your ESO. Show your work;for the calculations. If you use additional documents for the calculations;label them with your name and course number (MBA 570) and submit them as well.;Each question is worth 10 points.;1.;Consider a project with free cash;flows in one year of $141,799 or $181,108, with each outcome equally likely.;The initial investment required for the project is $60,000, and the project?s;cost of capital is 20%. The risk-free interest rate is 6%;a.;The;NPV for this project is $__________. (Round;to the nearest dollar.);b.;Suppose;that to raise the funds for the initial investment, the project is sold to;investors as an all-equity firm. The equity holders will receive the cash flows;of the project in one year. How much money can be raised this way? In other;words, the initial market value of the unlevered equity is $__________. (Round to nearest dollar.);c.;Suppose;the initial $60,000 is instead raised by borrowing at the risk-free investment;rate. The cash flows of the levered equity and its initial value according to;MM are (fill in the table below rounding;to the nearest dollar);Date 0;Date 1;Initial Value;Cash Flow;Strong Economy;Cash Flow;Weak Economy;Debt;$60,000;$;$;Levered Equity;$;$;$;2.;Acort;Industries owns assets that will have a 60% probability of having a market;value of $55 million in one year. There is a 40% chance that the assets will be;worth only $25 million. The current risk-free rate is 8%, and Acort?s assets;have a cost of capital of 16%.;a.;If;Acort is unlevered, the current market value of its unlevered equity is $;million. (Round to three decimal places.);b.;Suppose;instead that Acort has debt with a face value of $21 million due in one year.;According to MM, the current market value of its levered equity is $;million. (Round to three decimal places.);c.;The;expected return of Acort?s equity without and with leverage is (fill in the table below rounding to two;decimal places);Expected;Return;Without;Leverage;%;With;Leverage;%;d.;The;lowest possible realized return of Acort?s equity without and with leverage is (fill in the table below rounding to two;decimal places);Expected;Return;Without;Leverage;%;With;Leverage;%;3.;Suppose;Microsoft has no debt and an equity cost of capital of 9.5%. The average;debt-to-value ratio for the software industry is 12.8%. If Microsoft took on;the average amount of debt for its industry, the cost of its equity would be;%. (Round to two decimal;places.);4.;Hubbard;Industries is an all-equity firm whose shares have an expected return of 10%. Hubbard;does a leveraged recapitalization, issuing debt and repurchasing stock, until;its debt-equity ratio is 0.54. Due to the increased risk, shareholders now;expect a return of 15%. Assuming there are no taxes and Hubbard?s debt is;risk-free, the interest rate on the debt is __________%. (Round to two decimal places.);5.;Arnell;Industries has just issued $20 million in debt (at par). The firm will pay;interest only on this debt. Arnell/s marginal tax rate is expected to be 30%;for the foreseeable future.;a.;Suppose;Arnell pays interest of 10% per year on its debt. The annual interest tax;shield is $__________ million. (Round to three;decimal places.);b.;The;present value of the interest tax shield is $__________ million. (Round to one decimal place.);c.;Suppose;instead that the interest rate on the debt is 6%. In this case, the present;value of the interest tax shield is $__________ million. (Round to one decimal place.);6.;Rogot;Instruments makes fine violins and cellos. It has $1.9 million in debt outstanding;equity valued at $2.3 million, and pays corporate income tax at a rate of 31%.;Its cost of equity is 12% and its cost of debt is 6%.;a.;Rogot?s;pre-tax weighted average cost of capital is __________%. (Round to two decimal places.);b.;Rogot?s;effective after-tax weighted average cost of capital is __________%. (Round to two decimal places.);7.;Rumolt;Motors has 71 million shares outstanding with a share price of $25 per share.;In addition, Rumolt has issued bonds with a total current market value of $854;million. Suppose Rumolt?s equity cost of capital is 9% and its debt cost of;capital is 5%.;a.;Rumolt?s;pre-tax weighted average cost of capital is __________%. (Round to two decimal places.);b.;If;Rumolt?s corporate tax rate is 40%, its after-tax weighted average cost of;capital is __________%. (Round to two;decimal places.);8.;Milton;Industries expects free cash flow of $9 million each year. Milton?s corporate;tax rate is 40%, and its levered cost of capital is 13%. Milton also has;outstanding debt of $18.66 million, and it expects to maintain this level of;debt permanently.;a.;Milton;Industries? value without leverage is $__________ million. (Round to two decimal places.);b.;Milton;Industries? value with leverage is $__________ million. (Round to two decimal places.);9.;Markum;Enterprises is considering permanently adding an additional $112 million of;debt to its capital structure. Markum?s corporate tax rate is 35%.;a.;Absent;personal taxes, the value of the interest tax shield from new debt is $;million. (Round to two decimal places.);b.;If;investors pay a tax rate of 35% on interest income, and a tax rate of 25% on;income from dividends and capital gains, the value of the interest tax shield;from new debt is $__________ million. (Round to two;decimal places.);10.;With;its current leverage, Arundel Corp. will have net income next year of $7;million. If Arundel?s corporate tax rate is 35%, and it pays 6% interest on its;debt, the additional debt Arundel can issue this year and still receive the;benefit of the interest tax shield next year is;$__________ million. (Round to three;decimal places.)

Paper#48072 | Written in 18-Jul-2015

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