Q1. Rumolt has 30 million shares outstanding with a price of $15 per share.

In addition, they have issu

of capital is 10% and its debt cost of capital is 5%. A. What is rumolts pretax weighted average cost of
cost of capital?
No. of shares
Share price
Total value of equity
Total value of Debt
Cost of equity
Cost of debt
Weight of equity
Weight of Debt

30 million
$15
$450 million
$150 million
10%
5%
0.75
0.25

A)Pretax WACC
B) Corporate Tax rate
After tax WACC

8.75%

Pretax WACC = cost of equity*weight of

35%
8.313%

Aftertax WACC=cost of equity*weight o

Q2.Your firm has $100 million in debt outstanding with a 100% interest rate. The terms of the loan req
marginal corporate tax rate is 40% and teh interest tax shields have the same risks as the loan. What

Debt
$100 million
Interest Rate
100%
repayment per year
$25 million
Corporate tax rate
40%
Discount rate to calculate PV of interest tax shield = 100% as risk is same as loan. So interest rate is d

Year

Opening Interest Repayme

Balance paid
nt
1
$100
$100
$25
2
$75
$75
$25
3
$50
$50
$25
4
$25
$25
$25
PV of interest Tax Shield

Q3. Suppose the corporate tax rate is 40%. Consider a firm that earns $1000 before interest and taxes
expenses each year, and it will no changes in working capital. The risk free rate is 5%. A. Suppose the
the value of the firms equity? B. Suppose the firm makes an interest payment of $500 per year. What
between the total value of the firm with leverage and without leverage? The difference in part (C) is e

Corporate tax rate

40%
EBIT
$1,000
Capex = Depreciation expenses. No change in WC
Risk free rate
15%
A) Company's cash flow is risk free. Hence, Re = 5%
Company pays out total net income as dividend.
No debt. So interest payment = 0
Net income =
$
600.00
Value of firm's equity=
$
12,000

(Net income = EBIT - Interest - tax paym

B) Company makes riskless interest payment.

EBIT
$1,000
Less Interest payment
$500
EBT
$500
Less Tax
$200
Net Income
$300
Value of equity
Interest Payment to Lenders
Value of debt

$6,000
$500
$10,000

C) Levered value of company = Value of equity + Value of debt

=
$16,000
Unlevered value of company
$12,000 (from answer A)
Difference
$4,000
This differebce is how much % of value of debt ($10,000)?
% of value of debt =
40%

. In addition, they have issued bonds with a total current market value of $150 million. Suppose Rumolt's equity
ax weighted average cost of capital? B. If rumolts corporate tax rate is 35%, what is its after tax weighted avera

C = cost of equity*weight of equity + Cost of debt*weight of debt

CC=cost of equity*weight of equity + Cost of debt*weight of debt*(1-Tax rate)

e. The terms of the loan require the firm to repay $25 million of the balance each year. Suppose that the
ame risks as the loan. What is the present value of the interest tax shields from this debt?

as loan. So interest rate is discount rate.

Closing Tax
balance shield
$75
$40
$50
$30
$25
$20
$0
$10

V of interest Tax Shield

PV of
interest
tax
shield
20
7.5
2.5
0.625
30.625

00 before interest and taxes each year with no risk. The firms capital expenditures equal its depreciation
e rate is 5%. A. Suppose the firm has no debt and pays out its net income as a dividend each year. What is
ent of $500 per year. What is the value of equity? What is the value of debt? C. What is the difference
he difference in part (C) is equal to what percentage of the value of the debt?

= EBIT - Interest - tax payment)

Suppose Rumolt's equity cost

after tax weighted average

Suppose that the

bt?

al its depreciation
each year. What is
the difference