The firm originally is 100% financed by equity (Unlevered firm). The EBIT for the firm is $20,000. The cost of capital for this unlevered firm is 10%. The tax rate is 40%.  Systematic risk of the asset is 2.  Now assuming that the firm issues $15,000 debt to buy back some shares (Levered firm), and the debts are traded at par value. Assuming that the cost of debt =8%. HINT: You may want to use the capital structure (suggested solution) Spreadsheet in the Brightspace

 

1) What is the annual tax shield?

2) What is the present value of the annual tax shield?

3) What is the value for the unlevered firm.

4) What is the value for the levered firm.

5) What is the value for equity of the levered firm.

6) What is the cost of equity of the levered firm.

7)  What is the WACC of the levered firm.

 

If now the (levered) firm considers the following two mutually exclusive projects:

	Project A	Project B
0	-70000	-58000
1	30000	27000
2	24000	30000
3	45000	26000

8) What is the cross-over rate for these two projects? 

9) The CEO and the CFO of the underlying firm have different opinions on projects A and B. The CEO prefers IRR, while the CFO prefers NPV to make decisions. If the decision is made by choosing the project with the higher IRR rather than the one with the higher NPV, how much, if any, value will be forgone?

Answer rating: 100% (QA)

1 Annual tax shield Interest expense Tax rate 15000 008 04 480 ... View the full answer