# Capital Structure Problems

1. A company is considering a project that will be financed with debt and equity. The total

investment is \$500,000, of which \$200,000 is financed with debt with an annual interest rate of 10%.

The EBIT is \$100,000 every year, in

perpetuity. The tax rate is 30% and the project’s WACC is 15%

p.a. Find the NPV of this project. (As we did in class, assume that depreciation equals

the investment

in fixed assets and other

non

operational cash flows.)

2. Why is it that all banks confor

m almost perfectly to the MM 1963 result, whereas most other

companies fall far short of the financing œrecipe implied by MM 1963.

Be brief.

3. The book value of a firm’s equity is \$500,000, but the market value of equity is \$700,000. The

firm’s debt has

a book and market value of \$400,000. The corporate tax rate is 30% and the cost

of debt is 11%, whereas the cost of equity is 16%. Find the firm’s weighted average cost of

capital (WACC).

4. Explain why the market value of equity generally differs from i

ts book value.

Be specific and

brief.

5

. A company with \$10 million in assets (book value) has just changed its capital structure from

D = \$3 million to D = \$5 million (these are both book and market values of debt). The corporate

tax rate is 30%. When it

had D = \$3 million the market value of its equity was \$8 million. Find

the market value of the equity now that the company has \$5 million in debt.

6

. Wanton Soups, Inc. has a weighted average cost of capital (WACC) of 10.5 percent. The firm’s

cost of equ

ity is 15 percent, its tax rate is 40 percent, and its

market

debt

to

equity ratio (D/E) is

1.0. What is Wanton’s pre

tax cost of debt?

7. A project requiring an investment of \$2 million is expected to generate an EBIT of \$243,000

per year, forever. The equity por

tion of the investment is \$1.3 million. The corporate tax rate is

30%, the annual cost of equity is 15%, and the annual cost of debt is 11%. Find the NPV of this

project using the two methods described in class; that is, using the traditional method and th

e

WACC method. (Notes: calculate the WACC as a percentage with 4 decimals (e.g., 12.1234%)

and assume, a

s we did in class, that depreciation equals

the investment in fixed assets and other

non

operational cash flows.)

8

. A project has an EVA of \$4

million

and an NPV of \$12 million. What is the project’s WACC?

9

.

The accounting statements of BuschBev, Inc. indicate that it had operating profits of \$323

million last year,

that it

paid \$53 million in financial expenses (i.e., interest), and

that it

paid \$54

million in taxes.

\$1.5 billion in assets,

and its WACC wa

s 10%. How much

EVA

did the company generate last year? NOTE: Assume

that BuschBev wa

s subject to the same

flat tax rate on all of its pre

tax earnings

.