Question

3. Suppose the corporate tax rate is 40%, investors pay a tax rate of 20% on income from dividends or capital gains and a tax rate of 30% on interest income. Rally, Inc., currently an all-equity firm, is considering adding permanent debt through a levered recapitalization (Rally plans to raise 300 million through debt and payout the proceeds to shareholders). Interest Rally will be paying each year is expected to be $15 million. Rally will pay this interest expense by cutting its dividend.

a) Find after-tax cash flow to debtholders from the new debt

b) How much shareholders would receive in after-tax money (out of those $15 million that would be designated for dividends) if the firm did not change its capital structure?

c) Find Rally’s effective tax advantage of debt. How is it related to cash flows you computed in questions a) and b)

d) Compute expected change in the value of the company after the recapitalization. Does the value of the company increase or decrease as a result of recapitalization? Explain briefly

Answer #1

. Suppose the corporate tax rate is 35% and investors pay a tax
rate of 15% on income from dividends or capital gains and a tax
rate of 29% on interest income. Your firm adds debt so it pays an
additional $15 million in interest each year. It pays this interest
expense by cutting its dividend. a. How much will debt holders
receive after paying taxes? b. By how much will the firm need to
cut its dividends each year...

Slecat Corp. is in the 40% tax bracket and has a capital
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recapitalize to 40% debt and 60% equity. The firm will use the
proceeds from the debt issuance to repurchase shares of common
stock.
The corporation's existing stock has a...

a. What is the relative tax advantage of corporate debt if the
corporate tax rate is Tc = .39, the personal tax rate is Tp = .25,
but all equity income is received as capital gains and escapes tax
entirely (TpE = 0)? (Round your answer to 2 decimal places.)
Relative tax advantage
b. How does the relative tax advantage change if the company
decides to pay out all equity income as cash dividends that are
taxed at 15%? (Do...

Ajax has a tax rate of 30% and an EBIT of $50 million. The
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a) What is the value of the unlevered firm? What is the cost of
equity for the unlevered firm? What is the WACC of the unlevered
firm?
b) Now suppose that Ajax issues $90 million in debt to buy back
stock. The cost of debt is 8%. For the levered firm, find the value
of the levered firm, the cost...

Suppose the corporate tax rate is 40 %. Consider a firm that
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with no risk. The firm's capital expenditures equal its
depreciation expenses each year, and it will have no changes to
its net working capital. The risk-free interest rate is 8 %. a.
Suppose the firm has no debt and pays out its net income as a
dividend each year. What is the value of the...

Suppose the corporate tax rate is 40 %. Consider a firm that
earns $ 1,000 in earnings before interest and taxes each year with
no risk. The firm's capital expenditures equal its depreciation
expenses each year, and it will have no changes to its net working
capital. The risk-free interest rate is 4%. a. Suppose the firm
has no debt and pays out its net income as a dividend each year.
What is the value of the firm's equity? b....

XYZ Corp. had operating income this year of $120 million and is
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free cash flow to equity (FCFE)?
Select one:
A. $15 million...

27. Now that your firm has matured, you are considering adding
debt to your capital structure for the first time. Your all-equity
firm has a market value of $21 million and you are considering
issuing $2.1 million in debt with an interest rate of 9% and
using it to repurchase shares. You pay a corporate tax rate of
25%. Assume taxes are the only imperfection and the debt is
expected to be permanent.
a. What will be the total value...

Newcastle Inc. currently has no debt, annual earnings before
interest and taxes of $76 million and an average tax rate of 34%.
Net income is expected to stay constant forever. The firm pays out
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Using the CAPM, the firm estimates that its cost of equity is
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The firm is considering issuing bonds worth...

Suppose the corporate tax rate is 40%. Consider a firm that
earns $1000 before inter-est and taxes each year with no risk. The
firm’s capital expenditures equal its depreciation expenses each
year, and it will have no changes to its net working capital. The
risk-free interest rate is 5%.
a. Suppose the firm has no debt and pays out its net income as a
dividend each year. What is the value of the firm’s equity?
b. Suppose instead the firm...

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