Douglass & Frank has a debt-equity ratio of 0.35. The pre-tax cost of debt is 8.

ID: 2702459 • Letter: D

Question

Douglass & Frank has a debt-equity ratio of 0.35. The pre-tax cost of debt is 8.2 percent while the unlevered cost of capital is 13.3 percent. What is the cost of equity if the tax rate is 39 percent? (Round to the 2nd decimal XX.XX%)
The June Bug has a $270,000 bond issue outstanding. These bonds have a 7.5 percent coupon, pay interest semiannually, and have a current market price equal to 98.6 percent of face value. The tax rate is 39 percent. What is the amount of the annual interest tax shield? (Round to the nearest penny)
D. L. Tuckers has $21,000 of debt outstanding that is selling at par and has a coupon rate of 7.5 percent. The tax rate is 32 percent. What is the present value of the tax shield?
Lamont Corp. uses no debt. The weighted average cost of capital is 11 percent. The current market value of the equity is $38 million and there are no taxes. What is EBIT?
Bruce & Co. expects its EBIT to be $100,000 every year forever. The firm can borrow at 10 percent. Bruce currently has no debt, and its cost of equity is 20 percent. The tax rate is 34 percent. What will the value of Bruce & Co. be if the firm borrows $54,000 and uses the loan proceeds to repurchase shares?

Unlevered cost of equity = 13.3%

Levered cost of equity = Unlevered cost of equity + ( unlevered cost of equity - cos0.0t of debt) ( 1 - tax) debt / equity ratio

Levered cost of equity = 0.133 + ( 0.133 - 0.082)(1 - 0.39)0.35

Levered cost of equity = 0.133 + 0.010889

Levered cost of equity = 0.1439 or 14.39%

Annual tax shield = 270,000 * 0.075 * 0.39 = $7,897.50

Present value of tax shield = 21,000 * 0.32 = 6,720

Value of unlevered firm = 38,000,000

Value of unlevered firm = EBIT / WACC

38,000,000 = EBIT / 0.11

EBIT = $4,180,000

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