The Dance Studio is currently an all-equity firm that has 22,000 shares of stock

outstanding with a market price of $27 a share. The current cost of equity is 12
Q1 percent and the tax rate is 35 percent. The firm is considering adding $225,000 of debt
with a coupon rate of 6.25 percent to its capital structure. The debt will sell at par.
What will be the levered value of the equity?

Particulars
No of Shares
Market Price
Total Equity
Ke
Tax Rate

Debt
Kd

Unlevered Cost of Equity

Ke = Ku + (Ku – Kd)*(1 – T)D/E (1)

Levered Cost of Equity

Tax Shield

Value of Levered Firm

Value of unlevered Firm

Amt
22000
27
594,000
12%
35%

225,000
6.25%

9.82%

10.70%

78,750

672,750

447,750
Salmon Inc. has debt with both a face and a market value of $227,000. This debt has a coupon rate of
7 percent and pays interest annually. The expected earnings before interest and taxes is $87,200, the
tax rate is 35 percent, and the unlevered cost of capital is 12 percent. What is the firm's cost of
equity?

Debt Market Value $ 227.0 Thousand Unlevered Value $ 472.3 Thousand

Expected Earnings $ 87.2 Thousand Levered Value $ 551.8 Thousand
Coupon Rate 7% Value of Equity $ 324.78
Tax Rate 35%
Unlevered Cost of Capital 12%
Cost of Equity 14.27%
3. The Winter Wear Company has expected earnings
before interest and taxes of $3,800, an unlevered
cost of capital of 15.4 percent and a tax rate of 35
percent. The company also has $2,600 of debt with a
coupon rate of 5.7 percent. The debt is selling at par
value. What is the value of this firm?
EBIT 3800
Unlevered cost of capital is (Ka/kd) 15.40%
Tax rate 35%

Debt 2600
Kd 5.70%

Value of the unlevered Firm 16038.961039

Value of the levered firm 16948.961039

Ka 10.30%
Tax Rate 34%
EBIT 1900

Debt 4000
Kd 7%

Value of Unlevered firm 12174.75728

PV of Interest Tax Shield 1360
Value of Levered firm 13534.75728
Wd 0.30
We 0.70

Ke 11.214%
Cost of debt ( Kd) 7.35%
Unlevered Cost of Capital 12.80%
Tax rate 34%
Levered Cost of Equity 15.07%

Ke = Ka + (D/E) ( Ka - Kd)*(1 - tax)

Implying D/E = (Ke - Ka)/((Ka - Kd)*(1 - tax))

D/E ratio =
63.11%
Q6 Longmont Inc. is a levered firm with a cost of equity of 12 percent and a cost of debt
of 6 percent. The required return on the assets is 10 percent. What is the firm's debtequity
ratio if there are no taxes?

Levered Firm (No taxes)

Ke 12%
Kd 6%
Ka 10%

D/V 0.3333
E/V 0.6667

D/E 0.5
 A firm has a total value of $548,000 and debt valued at $262,000. What is the weighted
Q7 average cost of capital if the after tax cost of debt is 7.2 percent and the cost of equity is
12.6 percent?

Value of Firm 548000

Value of Debt 262000
Value of Equity 286000
Cost Of Debt 7.20%
Cost Of Equity 12.60%

Weighted Average Cost of Capital 10.02%

(We*ke+Wd*Kd)
Weights
47.81%
52.19%
Jelco has a target debt-to-value ratio of .55. The pretax cost of debt is 8.6 percent, the tax
rate is 35 percent, and the unlevered cost of equity 13.4 percent. What is the target cost of
equity?

Target D/E 0.55

Pretax cost of debt 8.6%
Unlevered cost of equity 13.4%
Tax Rate 35.0%

Target cost of equity 17.2%

9. TTC is planning to raise $3.25 million for three
years at an interest rate of 7.35 percent to
finance their expansion. The Alban County Board
of Commissioners has just offered the firm the
$3.25 million they need at 5.25 percent if the
firm builds in Alban County, pays the interest
annually, and repays the principal at the end of
three years. What is the net present value of the
loan to TTC if the firm's tax rate is 34 percent and
it accepts the county's offer?
FcFF 3.25 million
Interest rate 7.35%
34%
Interest rate offered by Alban County 5.25%

Annual interest Payment 0.17062500 million

After tax annual payment 0.11261250 million

PVIF Payment Made

1 0.931532370749883 0.11261250
2 0.8678 0.11261250
3 0.8083 0.11261250
4 0.8083 3.25

Net present Value 0.329372999649

0.1049021891
0.0977251275
0.0910246838
2.626975
2.9206270004 Total

million
Kd=Rf 4.36%
Cost 125
D/E 0.65
Re 6.10%
Debt 1.80%

Total equity raised 75.76

Total debt raised 49.24

Cost of rasing equity 4.62

Cost of rasing debt 0.89

Total flotation cost 5.51

Q12 Hilltop Paving has a levered equity cost of capital of 14.92 percent. The debt-to-value
ratio is .4, the tax rate is 34 percent, and the pretax cost of debt is 7.2 percent. What is
the estimated unlevered cost of equity?

Levered

Ke 14.92%
D/V 0.4
Tax rate 34%
Kd 7.20%

E/V 0.6
Ka 11.83%

Unlevered

Ke = Levered Ka 11.83%
 Webster Corp. is planning to build a new shipping depot. The initial cost of the
investment is $1.18 million. Efficiencies from the new depot are expected to reduce
Q13 annual costs by $105,000 forever. The corporation has a total value of $62.4 million
and has outstanding debt of $38.7 million. What is the NPV of the project if the firm
has an aftertax cost of debt of 5.8 percent and a cost equity of 12.6 percent?

Cost of Investment 1.18

Annual Savings 0.105

Total Value 62.4

Outstanding Debt 38.7
Value of Equity 23.7

Kd (After Tax) 5.80%

Ke 12.60%

WACC 8.38%

PV of Savings (Perpetuity) (Inflow) 1.252581

NPV (Inflow - Outflow) 0.072581

A firm has a project with an NPV of -$52 million. If it has access to risk-free government
financing that can create a permanent annual tax shield of $5 million, what is the APV
of the project assuming the risk-free interest rate is 6%?

NPV $ -52 mn
Annual Tax Shield $ 5 mn
Risk Free Interest Rate 6%

APV =NPV+Present Value of Tax Shield

$ 31 mn
A project costs $14 million and is expected to produce cash flows of $4
million per year for 15 years. The opportunity cost of capital is 20%. If
the firm has to issue stock to undertake the project and issue costs are
$1 million, what is the project's APV?
Issue Cost 3.7 mn dollar
Investment 14 mn dollar
FCFF 4 mn dollar
No. of years 15 years
Cost of capital, Ka 0.2 For unlevered firm

Year 0 1
CF -14 4
PV of CF 4.701891 mn dollar
Issue cost 1 mn dollar
Project's APV 3.701891 mn dollar
2 3 4 5 6 7 8 9 10 11
4 4 4 4 4 4 4 4 4 4
12 13 14 15
4 4 4 4
 Cost of facility 9.7 mn
D/E 1.5
Ke 6%
Kd 1%

Weight of equity 1/(1+D/E) 0.4

Weight of debt 1-We 0.6

Average flotation 3%
We*ke+Wd*kd

Fundes needed 10 mn (cost of facility/1-average flotation)

Flotation Cost 0.3 mn (funds needed-Cost of Facility)
Required Fund 200
NPV of unleavered firm 40
PV of financing -20

APV = NPV of unlevered

project + PV of financing
benefit

APV = 20
Q18 Johnston Company has a 7% cost of debt, a 50% debt ratio, and a 15% cost of equity.
The marginal tax rate is 25%. What is Johnston's WACC if it were 100% equity
financed?

Kd 7%
D/E 1
Ke 15%
Marginal t 25%
Wd 50%
We 50%

Ka 11.000%

WACC would be 10.125% in case of funds being 100%e equity financed.

 Mirion Tech, Inc., has rE of 12%, an rD of 6%, at a debt-equity ratio of 0.50. Mirion
plans to raise enough preferred stock to retire half of their outstanding common stock,
Q19 which currently has a market value of $7 million. If the preferred stock has an
expected rate of return of 10%, what is the new WACC? (Assume a 35% marginal
corporate tax rate and that rD remains at 6%.)

Re 12%
Rd 6%
D/E 0.5

Value of Equity 7 million

Rp 10%
Tax 35%

Type Value Cost V*C

Equity 7 12% 0.84
Preference 7 10% 0.7
Debt 7 6% 0.42
Total 21 1.96

WACC 9.33%
D 1 7
E 2 7 7
A firm uses $30 million of debt, $10 million of preferred stock, and $60 million of common
equity to finance its assets. If the before-tax cost of debt is 8%, cost of preferred stock is
10%, and the cost of common equity is 15%, calculate the weighted average cost of
capital for the firm assuming a tax rate of 35%.

Debt $ 30 mn
Stock $ 10 mn
Equity $ 60 mn
Before Tax cost of debt 8%
Cost of preferred stock 10%
Cost of common equity 15%
Tax Rate 35%

WACC 11.56%
Given are the following data for Golf Corporation:
Market price/share = $12; Book value/share = $10; Number of shares
outstanding = 100 million; Market price/bond = $800; Face value/bond =
$1,000; Number of bonds outstanding = 1 million. Calculate the proportions of
debt (D/V) and equity (E/V) for Golf Corporation that you should use for
estimating its weighted average cost of capital (WACC)
Market Price per share 12
Book value 10
Shares outstanding 100 million

Market price per bond 800

Face value per bond 1000
Bonds outstanding 1 million

Value of debt 800 million

Value of equity 1200 million

D/V 0.4
E/V 0.6
A firm has debt beta of 0.2 and an asset beta of 1.9. If the debt-equity ratio is 75%,
what is the levered equity beta?

Debt beta 0.2

Asset Beta 1.9
D/E 75%

βE= βA+ (D/E) × (βA- βD).

1.9 + (0.75) × (1.9 - 0.2)

Leveraged Beta 3.175

Debt 2.5
Rd 11%
Rds 8%
Tax 34%

Benefit of perpetual tax shield if status quo 0.0935

NPV of tax shield 0.85

Benefit of perpetual tax shield with subsidized loan 0.068

NPV of tax shield 0.618182

Benefit of subsidy 0.075

NPV of perpetual subsidy 0.681818

Benefit of subsidized loan 0.45

Q24 A project costs $14 million and is expected to produce cash flows of $4 million per
year for 15 years. The opportunity cost of capital is 20%. If the firm has to issue stock
to undertake the project and issue costs are $1 million, what is the project's APV?

Project's cost 14
Opportunity cost of capital 20%
Annual cash flows 4
Number of years 15

Shares issuing cost 1

Adjusted Present Value (APV) $ 3.70

 A firm uses $30 million of debt, $10 million of short-term debt, and $60 million of
common equity to finance its assets. If the before-tax cost of debt is 8%, after-tax cost
of short-term debt is 6%, and the cost of common equity is 15%, calculate the
25 weighted average cost of capital for the firm assuming a tax rate of 25%.

Debt 30
Short Term Debt 10
Common Equity 60

Kd 8%
Kd (Short Term Debt) (After Tax) 6%
Ke 15%
Tax 25%

WaCC ke*we+kd*wd (1-t)

11.40%
 million
million
million

ke*we+kd*wd (1-t)