Corporate Finance

Questions and Practice problems_Chapter 18

Chapter 18:
Concept questions (page 574 textbook): 2, 3, 4
Questions and Problems (page 575 textbook): 3, 5, 8

Q3: The cash flows to equity holders will be the firm’s net income
Sales $3,900,000
COGS 2,010,000
G & A costs 1,215,000
Interest 123,000
EBT $552,000
Taxes $220,800
NI $331,200

a, Since this cash flow will remain the same forever, the present value of cash flows available to
the firm’s equity holders is a perpetuity. We can discount at the levered cost of equity, thus
PV(Flow-to-equity) = $331,200 / 0.19 = $1,743,157.90
b, The value of a firm is equal to the sum of the market values of its debt and equity, or:
VL = B + S
The company has a debt-to-equity ratio of 0.40 so B / $1,743,157.90 = 0.40
=> B = $697,263.16
So, the value of the company is:
V = $2,440,421.06

Q5:
a, The equity beta of a firm financed entirely by equity is equal to its unlevered beta.
North Pole
βEquity = [1 + (1 – tC)(B/S)]βUnlevered
βEquity = [1 + (1 – .35)($2,900,000/$3,800,000](1.1)
βEquity = 1.65
South Pole
βEquity = [1 + (1 – tC)(B/S)]βUnlevered
βEquity = [1 + (1 – .35)($3,800,000/$2,900,000](1.1)
βEquity = 2.04
b. North Pole:
RS = RF + βEquity(RM – RF)
RS = 3.2% + 1.65(10.9% – 3.2%)
RS = 15.91%
South Pole:
RS = RF + βEquity(RM – RF)
RS = 3.2% + 2.04(10.9% – 3.2%)
RS = 18.91%

Q8: Whether the company issues stock or issues equity to finance the project is irrelevant. The
company’s optimal capital structure determines the WACC . In a world with corporate taxes:
RWACC = [B / (B + S)](1 – tC)RB + [S / (B + S)]RS
RWACC = .80(1 – .34)(.069) + .20(.108)
RWACC = 5.8%
NPV = –$45,000,000 + $3,100,000 / 0.058
NPV = $8,448,275.86