Quiz 7 in Finance 4360: After-Tax Cash Flows and Conflicts of Interest, Quizzes of Finance

Download Quiz 7 in Finance 4360: After-Tax Cash Flows and Conflicts of Interest and more Quizzes Finance in PDF only on Docsity! Finance 4360; Key to Quiz 7; Spring 2008; 9:00 Class Note: For any question with numbers, all of the points are earned by setting up solutions. There are no points for any calculations. As a result, you will likely earn a higher grade on this quiz if you simply set up problems but never touch your calculator. “Setting up solutions” may involve writing a single number. For problems 1 and 2 assume that the corporate tax rate is 35%, that the personal tax rate on equity income is 15%, and that the personal tax rate on interest income is 30%. 1. ATAway Airlines has earnings before interest and taxes of $100,000 per year. Assume that ATAway issues risk- free bonds for $500,000 that never mature. What is the after-tax cash flow per year paid to investors by the firm if the risk-free interest rate is 3%? 100,000(1 – .35) + (.35)(500,000)(.03) or, (100,000 – (500,000)(.03))(1 – .35) + 500,000(.03) 2. There is a 15% chance that DellFired Inc.’s EBIT will be $75 million, a 60% chance that it will be $100 million, and a 25% chance that it will be $125 million. What is DellFired’s effective tax advantage of debt if their current interest expense is $80 million?    35.85.CE       3.1 15.11 1*    C E   3. What type of conflict of interest do covenants attempt to address? Stockholder-bondholder conflict 4. How does an indirect cost of financial distress differ from a direct cost of bankruptcy? Cost associated with an increased chance of going bankrupt rather than from actually going bankrupt. 5. Ford CEO Bucks Inc. currently has no debt and is expected to generate free cash flows of $100 million per year forever. If Ford CEO Bucks issues permanent debt of $75 million at an interest rate of 4%, the firm’s free cash flows will drop to $95 million per year forever. If Ford CEO Bucks issues the debt, what will be its value if its corporate tax rate is 35% and if the appropriate discount rate for Ford CEO Bucks’ future cash flows is 7%?  7535. 07. 95 LV