Answer Happy

Chapter 15
15-5. Your firm currently has $100 million in debt outstanding with a 10% interest rate. The terms of the loan require the firm to repay $25 million of the balance each year. Suppose that the marginal corporate tax rate is 25%, and that the interest tax shields have the same risk as the loan. What is the present value of the interest tax shields from this debt?
Year 0 1 Debt 100 75 Interest 10 TaxShield 2.50
PV of the tax shield at 10%
2 3 4
50 25 0 7.5 5 2.5 1.88 1.25 0.63
$5.19
Note: The interest paid in Year 1 is based on the amount of Debt in Year 0, Likewise, the interest paid in Year 2 is based on the amount of Debt in Year 1 and so on.
15-10. Rogot Instruments makes fine violins and cellos. It has $1 million in debt outstanding, equity valued at $2 million, and pays corporate income tax at a rate of 21%. Its cost of equity is 12% and its cost of debt is 7%.
a. What is Rogot’s pretax WACC?
b. What is Rogot’s (after-tax) WACC?
a. b.
15-14. Restex maintains a debt-equity ratio of 0.85, and has an equity cost of capital of 12%, and a debt cost of capital of 7%. Restex’s corporate tax rate is 25%, and its market capitalization (E) is $220 million.
a. If Restex’s free cash flow is expected to be $10 million in one year, what constant expected future growth rate is consistent with the firm’s current market value?
b. Estimate the value of Restex’s interest tax shield.
a.
b.
r  E r D r2121710.33% wacc ED E ED D 3 3
r  E r  D r (1 )21217(0.79)9.84% wacc EDE EDD c 3 3
1 1.85
12%
0.85 1.85
7%10.25 8.90% 
WACC
VL ED2201.85407
FCF WACC  g
 10 0.0890  g
g  0.0890 
10 407
 6.44%
pretax WACC  1 1.85
VU  FCF pretax WACC  g
12%  0.85 7%  9.70% 1.85
 10 $307 million 0.0970  0.0644
PVInterest Tax Shield407307$100 million