Homework to chapter 15

Ch15
6.

Ru=9.2%, D/V=0.13, Rd=6% ==> Re=9.2%+(9.2%-6%)*(0.13/0.87)=9.68%
15.
Vu=5/0.15 = $33.33 million
V(L)=V(U)+D*T= 33.33+19.05*0.35 = $40 million
17.
(10/0.08)-50 = 75 million
75/5=$15/share
21.
Re=5% + 1.1(15%-5%)= 16%==>Vu=16/0.16 = $100 million
V(L)= Vu+D*Tc= (15/0.16)+40*0.35 = $107.75 million
Additional Questions

1
Khieu Auto expects its EBIT to be $95,000 every yearforever. The firm can borrow at 10%. Khieu Auto currently has no debt, and its cost of equity is 22%. If the tax rate is 35%, what is the value of the firm? What will the value be if Khieu Auto borrows$60,000 and uses the proceeds to repurchase shares? What is the cost of equity after recapitalization? What is the WACC? What are the implications for the firm’s capital structure decision?
Answers:V(U)= EBIT*(1-Tc)/Ru = (95,000*0.65)/0.22= 280,681.82
V(L) = V(U) + (D*T) = 280,681.82+ 60,000*0.35 = 301,681.82
R(E)= 0.22+ (0.22-0.1)*0.65*(60000/(301681.82-60000)) = 23.9%
WACC=((301681.82-60000)/301681.82)*23.9% + (60000/301681.82)*10%*0.65 = 20.47%
or WACC = R(U)*(1-(T*(D/V)) = 0.22*(1- (0.35*60,000/301681.82)) = 20.47%
2
Astromet is financed entirely by common stock and has a betaof 1.0. The firm pays no taxes. The stock has a price-earnings multiple of 10 and is priced to offer a 10% expected return. The company decides to repurchase half the common stocks and substitute anequal value of debt. If the debt yields a risk-free 5%, calculate
The beta of the common stock after the refinancing.
The required return on the common stock before the refinancing.
The requiredreturn on the common stock after the refinancing.
The required return on the debt.
The expected return on the company after the refinancing.
Answers:

Since the debt is risk-free, βd=0.
Inaddition, no tax ==> Tc= 0
Buyback half the common stocks ==> D=1, E=1, V= 2
βe=βu+(βu-βd)*(D/E)*(1-Tc)= 1+(1-0)*(1/1)*(1-0) = 2
or βa(=1)= (E/V)βe + (D/V)βd ==> βe= 2
Ru=10% (from the question)...