Download Finance - Key to Quiz 7 - Spring 2008 | FIN 4360 and more Quizzes Finance in PDF only on Docsity! Finance 4360; Key to Quiz 7; Spring 2008; 2:00 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, 2, and 3, 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. Briefly give the basic reason that if two firms have the same EBIT, the higher growth firm will tend to have a lower debt to value ratio. 1) if two firms have the same EBIT, they will have the same tax-optimal debt leves 2) high grown firms have higher values relative to current EBIT due to higher future growth 2. Assume that DellFired’s equity has a market value of $100 million and a book value of $20 million. Assume also that DellFired’s debt (which is risk-free) has a market value of $30 million and a book value of $27.5 million. Finally, assume that DellFired’s cost of equity capital is 12% and the risk-free rate is 4%. What is DellFired’s after-tax weighted average cost of capital? 35.104. 30100 30 12. 30100 100 3. Ford CEO Bucks has a 10% chance of earning $100 million, a 50% chance of earning $125 million, and a 40% chance of earning $150 million. Ford CEO Bucks’ current interest expense is $110 million. What is Ford CEO Buck’s effective tax advantage for issuing debt that will pay an additional $10 million per year of interest? 35.9.CE 3.1 15.11 1* C E 4. What types of firms are most likely to experience a loss of value due to empire building? High cash after firm makes interest payments and undertakes positive NPV projects 5. In general, management knows more than outside investors about the value of a firm’s assets. How does this difference in information impact how stock prices react when a firm announces plans to issue additional shares of stock? Stock prices decline since the decision to issue stock signals that management believes the stock is overvalued
