Reference no: EM13245580
Directions: Answer the following five questions on a separate document. Explain how you reached the answer or show your work if a mathematical calculation is needed, or both. Submit your assignment using the assignment link in the course shell. Each question is worth five points apiece for a total of 20 points for this homework assignment.
1. Firm L has debt with a market value of $200,000 and a yield of 9%. The firm's equity has a market value of $300,000, its earnings are growing at a rate of 5%, and its tax rate is 40%. A similar firm with no debt has a cost of equity of 12%. Under the MM extension with growth, what is Firm L's cost of equity?
a. 11.4%
b. 12.0%
c. 12.6%
d. 13.3%
e. 14.0%
2. Your firm has debt worth $200,000, with a yield of 9%, and equity worth $300,000. It is growing at a 5% rate, and its tax rate is 40%. A similar firm with no debt has a cost of equity of 12%. Under the MM extension with growth, what is the value of your firm's tax shield, i.e., how much value does the use of debt add?
a. $92,571
b. $102,857
c. $113,143
d. $124,457
e. $136,903
3. Your firm has debt worth $200,000, with a yield of 9%, and equity worth $300,000. It is growing at a 5% rate, and its tax rate is 40%. A similar firm with no debt has a cost of equity of 12%. What is the value of the firm according to MM with corporate taxes?
a. $475,875
b. $528,750
c. $587,500
d. $646,250
e. $710,875
4. Gomez computer systems has an EBIT of $200,000, a growth rate of 6%, and its tax rate is 40%. In order to support growth, Gomez must reinvest 20% of its EBIT in net operating assets. Gomez has $300,000 in 8% debt outstanding, and a similar company with no debt has a cost of equity of 11%.
According to the MM extension with growth, what is the value of Gomez's tax shield?
a. $156,385
b. $164,616
c. $173,280
d. $182,400
e. $192,000
5. Trumbull, Inc., has total value (debt plus equity) of $500 million and $200 million face value of 1- year zero coupon debt. The volatility ( ) of Trumbull's total value is 0.60, and the risk-free rate is 5%. Assume that N(d1) = 0.9720 and N(d2) = 0.9050.
What is the value (in millions) of Trumbull's equity if it is viewed as an option?
a. $228.77
b. $254.19
c. $282.43
d. $313.81
e. $345.19
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