QUESTION 66 The following information applies to the next 10 problems. The Walla
ID: 2657009 • Letter: Q
Question
QUESTION 66
The following information applies to the next 10 problems.
The Wallace Corporation is a zero growth firm with an expected EBIT of $800,000 on a permanent basis, and corporate tax rate of 40 percent. Wallace uses no debt, and the cost of equity to an unlevered firm in the same risk class is 12.0 percent. The firm has 100,000 shares outstanding.
What is the value of the firm?
$2,500,000
$2,800,000
$3,800,00
$4,000,000
$4,400,000
1 points
QUESTION 67
What is the EPS (earnings per share) of the firm?
$4.0
$4.2
$4.4
$4.6
$4.8
1 points
QUESTION 68
What is the price per share of the firm's stock?
$34
$36
$38
$40
$44
1 points
QUESTION 69
The following information applies to the next 7 problems.
Now, the Wallace Corporation decides to change its capital structure by borrowing $1.5 million at 8% interest on a permanent basis, and repurchasing some of its stocks.
We still assume the same information from above.
The Wallace Corporation is a zero growth firm with an expected EBIT of $800,000 on a permanent basis, and corporate tax rate of 40 percent. When Wallace used no debt, and the cost of equity to an unlevered firm in the same risk class is 12.0 percent. The firm had 100,000 shares outstanding before the repurchase.
What is the value of the firm with $1.5 million debt, according to MM with corporate taxes?
$3,600,000
$3,800,000
$4,350,00
$4,600,000
$5,250,000
1 points
QUESTION 70
What is the value of equity?
$2,700,000
$3,100,000
$3,350,000
$3,450,000
$3,750,000
1 points
QUESTION 71
What is the firm's cost of equity when the firm uses $1,500,000 debt?
12.5%
13.16%
13.54%
14.25%
15.16%
1 points
QUESTION 72
What is the stock price of the firm at which shares are repurchased?
$38
$40.33
$43
$44
$46
1 points
QUESTION 73
What is the number of shares the firm repurchases with $1,500,000?
32,609
34,091
34,884
37,190
39,474
1 points
QUESTION 74
What is the EPS (earnings per share) of the firm, when the firm uses $1,500,000 debt?
$5.35
$5.53
$5.77
$6.05
$6.42
1 points
QUESTION 75
What is the firm's value when both corporate and personal taxes are considered. Assume that the personal tax rates of Wallace's investors are 30 percent on debt (interest) income and 20 percent (on average) on income from stocks.
$4,00,000
$4,211,333
$4,314,286
$4,471,429
$4,600,000
The Wallace Corporation is a zero growth firm with an expected EBIT of $800,000 on a permanent basis, and corporate tax rate of 40 percent. Wallace uses no debt, and the cost of equity to an unlevered firm in the same risk class is 12.0 percent. The firm has 100,000 shares outstanding.
Explanation / Answer
Question 66
Value of Firm = EBIT* (1-Tax rate)/ Cost of Equity
Given:
EBIT = $ 800,000
Tax rate = 40%
Cost of Equity
Therefore, Value of firm = $ 800,000* (1-40%) / 12%
=> $ 480,000 / 12%
ANSWER : VALUE OF FIRM=> $ 4,000,000
Q 67
EPS of firm = (EBIT - Interest * (1-Tax Rate)) / No. of Shares Outstanding
Given:
EBIT = $ 800,000
Tax rate = 40%
No. of Shares outstanding = 100,000
EPS = ($ 800,000 -0- (1-40%)) / 100,000
=> EPS = ($ 800,000* 0.60) / 100,000
=> 480,000/100,000
Answer EPS of firm = 4.8
Q 68
Price per share of firm's stock = Value of Firm / No. of Shares Outstanding
Note : In question 66, we have computed the value of the firm as $ 4,000,000
No. of Shares outstanding = 100,000
Answer: The Price per share of the firm = $4,000,000 / 100,000 = $ 40
Q 69
The MM theorem states that the market value of a firm is computed using its earnings power and the risk of its underlying assets, and is independent of the manner in which it finances its investments and distributes its dividends.
In other words, the capital structure does not influence the valudation of a firm, and leveraging does not increase the market value of the firm. Debt and Equity shareholders have the same priority.
Q 70
Value of firm with $ 1.5 Million Debt = $ 46,00,000 (See Question 69)
Less : Value of Debt issued = $ 15,00,000 (given)
Answer : Cost of Equity = $ 31,00,000
Q 71
Cost of Equity (when firm uses $ 1.5 Million of Debt)
Q 72
Value of firm after repurchase or recapitalization = Value of firm (refer question 69) / No. of shares outstanding
=> $46,00,000 / 100,000
Answer = $ 46
Q 73
No. of shares that the firm repurchases with $ 15,00,000 = $ 15,00,000/ 46 (refer question 72) = 32,609
Q 74
No. of shares outstanding after repurchase = 100,000 - 32,609 shares (see Q 73) = 67,391 shares
The EPS calculation will take 67,391 shares outstanding in to consideration
EPS = (Earnings (1- Tax) - Interest Payments* (1-Tax)) / Shares outstanding after re-purchase
=> EPS = (8,00,000 *(1-40%) - 15,00,000*8%*(1-40%)) / 67,391
=> EPS = (480,000 - 1,20,000*60%) / 67,391
=> EPS = (480,000 - 72,000) /67,391
=> EPS = $408,000 / 67,391 shares
Answer : EPS = $ 6.0542208 or $ 6.05
Cross- check
We can now cross-check/ verify the Stock price of the firm using the formula EPS ( Q 74) / Cost of Equity (Q 71)
=> $6.0542208/ ($13.161/100)
=> $ 6.0542208 / $.13161
=> 46.001222 0r $ 46 ( This is the value of firm after re-purchase or recapitalization) - Refer Question 72
Q 75
Personal tax on income from Equity = 20%
Cost of Equity
Therefore, Value of firm = $ 800,000* (1-40%) / 12%*(1+20%)
=> $ 480,000 / 14.4
ANSWER : VALUE OF FIRM=> $ 33,33,333 - A
Personal tax on interest on debt = 30%
Interest rate = 8%
Interest Income + personal tax = 10.4%
Value of firm when both corporate and personal taxes are factored in : $ 33,33,333 + $ 878,000 = $ 42,11,333
MM Proposition 1 V l = VU + rc* B => V l = (EBIT* (1-rc))/R0 + rc B Given: EBIT 8,00,000 rc = Tax rate 40% R0 = Cost of Equity 12% B = Total Debt 15,00,000 => 800000*(1-.4) / .12 + 1500000*.4 => 480,000/.12 + 600,000 => 40,00,000+600,000 (Value of leverage or tax shield) Answer The Value of the firm with corporate taxes = $ 46,00,000Related Questions
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