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Exam 17: Dynamic Capital Structures and Corporate Valuation

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Question 21

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The major contribution of the Miller model is that it demonstrates that

A) personal taxes decrease the value of using corporate debt.
B) financial distress and agency costs reduce the value of using corporate debt.
C) equity costs increase with financial leverage.
D) debt costs increase with financial leverage.
E) personal taxes increase the value of using corporate debt.

F) B) and C)
G) All of the above

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Question 22

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Exhibit 17.3 The total value (debt plus equity) of Wilson Dover Inc. is $500 million and the face value of its 1-year coupon debt is $200 million. The volatility (σ) of Wilson Dover's total value is 0.60, and the risk-free rate is 5%. Assume that N(d₁) = 0.9720 and N(d₂) = 0.9050. -Refer to Exhibit 17.3.What is the yield on Wilson Dover's debt?

A) 6.04%
B) 6.36%
C) 6.70%
D) 7.05%
E) 7.42%

F) B) and D)
G) B) and C)

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Question 23

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Exhibit 17.2 Kitto Electronics has an EBIT of $200,000, a growth rate of 6%, and its tax rate is 40%. In order to support growth, Kitto must reinvest 20% of its EBIT in net operating assets. Kitto has $300,000 in 8% debt outstanding, and a similar company with no debt has a cost of equity of 11%. -Refer to Exhibit 17.2.According to the MM extension with growth,what is the value of Kitto's tax shield?

Exhibit 17.1 Eccles Inc., a zero growth firm, has an expected EBIT of $100,000 and a corporate tax rate of 30%. Eccles uses $500,000 of 12.0% debt, and the cost of equity to an unlevered firm in the same risk class is 16.0%. -Refer to Exhibit 17.1.What is the firm's cost of equity?

In the MM extension with growth,the appropriate discount rate for the tax shield is the WACC.

Exhibit 17.2 Kitto Electronics has an EBIT of $200,000, a growth rate of 6%, and its tax rate is 40%. In order to support growth, Kitto must reinvest 20% of its EBIT in net operating assets. Kitto has $300,000 in 8% debt outstanding, and a similar company with no debt has a cost of equity of 11%. -Refer to Exhibit 17.2.According to the MM extension with growth,what is Kitto's unlevered value?

The Miller model begins with the MM model without corporate taxes and then adds personal taxes.

A local firm has debt worth $200,000,with a yield of 9%,and equity worth $300,000.It is growing at a 5% rate,and its tax rate is 40%.A similar firm with no debt has a cost of equity of 12%.Under the MM extension with growth,what is the value of your firm's tax shield,i.e.,how much value does the use of debt add?

Which of the following statements concerning the MM extension with growth is NOT CORRECT?

When a firm has risky debt,its equity can be viewed as an option on the total value of the firm with an exercise price equal to the face value of the debt.

Other things held constant,an increase in financial leverage will increase a firm's market (or systematic)risk as measured by its beta coefficient.