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Q Corporation and R Inc. are two companies with very similarcharacteristics. The only difference between the two companies isthat Q Corp. is an unlevered firm, and R Inc. is a levered firmwith debt of $5 million and cost of debt of 10%. Both companieshave earnings before interest and taxes (EBIT) of $2 million and amarginal corporate tax rate of 40%. Q Corp. has a cost of capitalof 15%.

a. What is Q’s firm value?

b. What is R’s firm value?

c. What is R’s equity value?

d. What is Q’s cost of equity capital?

e. What is R’s cost of equity capital?

f. What is Q’s WACC?

g. What is R’s WACC?

h. Compare the WACC of the two companies. What do youconclude?

i. What principle have you proven in this case?

j. Both companies are now evaluating a project that requires aninitial investment of $1.15 million and that will yield cashinflows of $500,000 per year for the next three years. Assume thatthis project has the same risk level as the individual firm’sassets. Should Q invest in this project? Should R invest in thisproject?

k. Based on your results for part (j), discuss the effects ofleverage and its tax shields effects on the future value of the twofirms.

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Keith Leannon
Keith LeannonLv2
28 Sep 2019

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Q Corporation and R Inc. are two companies with very similarcharacteristics. The only difference between the two companies isthat Q Corp. is an unlevered firm, and R Inc. is a levered firmwith debt of $5 million and cost of debt of 10%. Both companieshave earnings before interest and taxes (EBIT) of $2 million and amarginal corporate tax rate of 40%. Q Corp. has a cost of capitalof 15%

j. Both companies are now evaluating a project that requires aninitial investment of $1.15 million and that will yield cashinflows of $500,000 per year for the next three years. Assume thatthis project has the same risk level as the individual firm’sassets. Should Q invest in this project? Should R invest in thisproject?

k. Based on your results for part (j), discuss theeffects of leverage and its tax shields effects on the future valueof the two firms.

SFE Inc. has 1 million shares of common stock outstanding at a book value of $40 per share. The stock trades for $50 per share. It also has $10 million in face value of debt (corporate bonds of 5 years with coupon rate 10.4%, paid semi-annually) that trades at 110% of face value. The company’s common stock has abeta of 1.2. Treasury bills yield 2% and the market return is 10%. The corporate tax rate is 35%.

a) What is the total market value of equity?

b) What is the total market value of debt?

c) What is its ratio of debt to total firm value in the market-value driven capital structure?

d) What is the (annualized) before-tax cost of debt?

e) What is the after-tax cost of debt?

f) What’s the cost of equity?

g) What’s the after-tax WACC?

h) SFE is considering a project that costs $500,000 today. The project returns$150,000 each year, for the next five years. What is the NPV of the project?

Please answer ALL of these questions. It would really help me out! Thanks!

1. MV corporation has debt with Market value of $100 million, common equity with a book value of $100 million, and preferred stock woth $20 million outstanding. It's common equity trades at $50 per share, and the firm has 6 million shares outstanding. What weights should MV corporation use in its WACC

2. Book co. has 1.5 million shares of common stock equity with a par (book) value of $1.40, retained earnings of $28.1 million, and its shares have a market value of $51.74 per share. it also has debt with a par value of $19.1 million that is trading at 104% of par.

a. What is the market value of its equity?

b. What is the market value of its debt?

c. What weights should it use in computing its WACC?

3. Avicorp has a $10 million debt issue outstanding, with a 6% coupon rate. The debt has semiannual coupons, the next coupon is due in six months, and the debt matures in five years. It is currently priced at 95% of par value.

(a) What is Avicorp’s pretax cost of debt?

(b) If Avicor faces a 40% tax rate, what is its after-tax cost of debt? The after-tax cost of debt for Avicor is:

4. Dewyco has preferred stock trading at $50 per share. The next preferred dividend of $4 is due in one year. What is Dewyco’s cost of capital for preferred stock?

5. Steady Company's stock has a beta of 0.24. If the risk-free rate is 5.8% and the market risk premium is 7.1%, what is an estimate of Steady Company's cost of equity?

(round to one decimal place)

6. HighGrowth Company has a stock price of $20. The firm will pay a dividend of $1 next year, and its divident is expected to grow at a rate of 4% per year thereafter. What is your estimate of HighGrowth's cost of equity capital?

7. CoffeeCarts has a cost of equity of 15%, an effective cost of debt of 4%, and it's financed 70% with equity and 30% with debt. What is this firm's WACC?

8. AllCity Inc is financed 40% with debt, 10% with preferred stock, and 50% with common stock. Its pretax cost of debt is 6%. Its preferred stock pays an annual dividend of $2.50 and is priced at $30. It has an equity beta of 1.1. Assume the risk-free rate is 2%, the market risk premium is 7% and AllCity's tax rate is 35%. What is its after-tax WACC?

9. Growth company's current share price is $20 and is expected to pay a $1 dicidend per share next year. After that, the firm's dividends are expected to grow at a rate of 4% per year.

Growth company has existing debt issued three years ago with a coupon rate of 6%. The firm just issued new debt at a par with a coupon rate of 6.5%.

a. What is Growth Company's pre-tax cost of debt?

b. Growth Company also has preferred stock outstanding that pays $2 per share fixed dividend. If the stock is currently price at $28, what is Growth Company's cost of preffered stock?

c. Growth Company has existing debt issued three years ago with a coupon rate of 6%. The firm just issued new debt at par with a coupon rate of 6.5%. What is Growth Company's pretax cost of debt?

d. Growth Company has 5 million common shares outstanding and 1 million preferred shares outstanding, at its total book value is $50 million. Its liabilitities have a market value of $20 million. If Growth Company's common and preferred shares priced as in parts a and b, what is the market value of Growth Company's assets?

e. Growth Company faces a 35% tax rate. Given the information in parts a through d, and your answers to those problems, what is Growth Company's WACC?

10. A retail coffee company is planning to open 100 new coffee outlets that are expected to generate, in total, $15 million in free cash flows per year, with a growth rate of 3% in perpetuity. If the coffee company’s WACC is 10%, what is the NPV of this expansion?

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