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1) Book and market values of Sam Company:

Book=

Net working capital $20 $40 Debt
Long-term assets $80 $60 Equity
Total $100 $100

Market=

Net working capital $20 $40 Debt
Long-Term Assets $140 $120 Equity
$160 $160

Assume that MM theory holds true with taxes. There is no growth and $40 of debt is expected to be permanent. Suppose a 40% corporate tax rate.

a) How much of the firms value is accounted for by the debt generated tax shields?

b) How much better off is Jones Company shareholders if the firm barrows $20 more and uses it to repurchase stock.

2) Tax shields:

What is relative benefit of corporate debt if corporate tax rate is Tc:.35, personal tax rate is Tp:.35, but all equity income is received as capital gains and escape tax (TpE:0)? How does relative tax advantage change if company decides to pay all equity income as cash dividends taxed at 15%?

3) IRR

Let the 2 investments which are given below:
                Co          C1            c2
Alpha:  -400,000  +241,000   +293,000
Beta:   -200,000  +131,000   +172,000
Opportunity Cost of capital is 8%

If you were going to select alpha or beta by using IRR, which is the better choice?

Basic Finance, Finance

  • Category:- Basic Finance
  • Reference No.:- M914347

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