A Word document or an Excel spreadsheet and show the calculations you used to arrive at the answer.
Submit your answer to each of the problems in a Word document or an Excel spreadsheet and show the calculations you used to arrive at the answer. You must show calculations to receive credit.
Salinas Corporation has a net income of $15 million per year on net sales of $90 million per year. It currently has no long-term debt but is considering a debt issue of $20 million. The interest rate on the debt would be 7%. Salinas currently faces an effective tax rate of 40%. What would be the annual interest tax shield to Salinas if it goes through with the debt issuance?
Carbon8 Corporation wants to raise $120 million in a seasoned equity offering, net of all fees. Carbon8 stock currently sells for $28.00 per share. The underwriters will require a fee of $1.25 per share and indicate that the issue must be underpriced by 7.5%. In addition to the underwriter's fee, the firm will incur $785,000 in legal, administrative, and other costs. How many shares must Carbon8 sell to raise the desired amount of capital?
FM Foods is evaluating its cost of capital. Use the following information provided on December 31, 2017, to estimate FM's after-tax cost of equity capital.
Yield to maturity on long-term government bonds: 4.4%
Yield to maturity on company long-term bonds: 6.3%
Coupon rate on company long-term bonds: 7%
Historical excess return on common stocks: 6.5%
Company equity beta: 1.20
Stock price: $40.00
Number of shares outstanding (millions): 240
Book value of equity (millions): $5,240
Book value of interest-bearing debt (millions): $1,250
Tax rate: 35.0%
Sample Solution
Absolutely! Let's break down each problem and provide the solutions with calculations.
Problem 1: Salinas Corporation Interest Tax Shield
- Given:
- Debt issuance: $20 million
- Interest rate: 7%
- Tax rate: 40%
- Calculations:
- Annual interest expense: $20,000,000 * 0.07 = $1,400,000
- Interest tax shield: $1,400,000 * 0.40 = $560,000
- Answer: The annual interest tax shield to Salinas would be $560,000.
Problem 2: Carbon8 Corporation Seasoned Equity Offering
- Given:
- Net capital needed: $120 million
- Current stock price: $28.00 per share
- Underwriter's fee: $1.25 per share
- Underpricing: 7.5%
- Other costs: $785,000
Full Answer Section
- Calculations:
- Net price per share: $28.00 * (1 - 0.075) - $1.25 = $24.60 - $1.25 = $23.35
- Total cost other than per share cost: $785,000
- Amount needed from share sales: $120,000,000
- Number of shares: $120,000,000 / $23.35 = 5,139,186.30
- Since you can not sell a fraction of a share, you must round up.
- Answer: Carbon8 must sell 5,139,187 shares to raise the desired amount of capital.
Problem 3: FM Foods Cost of Equity Capital
- Given:
- Yield on government bonds (risk-free rate): 4.4% (0.044)
- Company long-term bond yield: 6.3% (0.063)
- Historical excess return (market risk premium): 6.5% (0.065)
- Company equity beta: 1.20
- Stock price: $40.00
- Shares outstanding: 240 million
- Book value of equity: $5,240 million
- Book value of debt: $1,250 million
- Tax rate: 35% (0.35)
- Calculations:
- Cost of equity capital (using Capital Asset Pricing Model - CAPM): Risk-free rate + (Beta * Market risk premium)
- Cost of equity: 0.044 + (1.20 * 0.065) = 0.044 + 0.078 = 0.122
- Cost of equity = 12.2%
- Answer: FM's after-tax cost of equity capital is 12.2%.
Word Document/Excel Spreadsheet:
For clarity, I recommend presenting your answers in a table format within a Word document or Excel spreadsheet, showing the givens, formulas used, and the final answers. Here's a sample of how you might structure it in a table:
Salinas Corporation
| Item | Calculation | Result |
|---|---|---|
| Debt Issuance | $20,000,000 | |
| Interest Rate | 7% | |
| Tax Rate | 40% | |
| Annual Interest Expense | $20,000,000 * 0.07 | $1,400,000 |
| Interest Tax Shield | $1,400,000 * 0.40 | $560,000 |
Carbon8 Corporation
| Item | Calculation | Result |
|---|---|---|
| Net Capital Needed | $120,000,000 | |
| Current Stock Price | $28.00 | |
| Underwriter's Fee | $1.25 | |
| Underpricing | 7.5% | |
| Other Costs | $785,000 | |
| Net Price Per Share | $28.00 * (1 - 0.075) - $1.25 | $23.35 |
| Number of Shares | $120,000,000 / $23.35 | 5,139,187 |
FM Foods
| Item | Given Value | Calculation | Result |
|---|---|---|---|
| Government Bond Yield | 4.4% | ||
| Company Long-Term Bond Yield | 6.3% | ||
| Historical Excess Return | 6.5% | ||
| Equity Beta | 1.20 | ||
| Cost of Equity (CAPM) | 0.044 + (1.20 * 0.065) | 12.2% |
By presenting your work in this organized format, you demonstrate a clear understanding of the calculations and ensure easy readability.
Carbon8 Corporation wants to raise $120 million in a seasoned equity offering, net of all fees. Carbon8 stock currently sells for $28.00 per share. The underwri
Solved 2. Carbon8 Corporation wants to raise $120 million in | Chegg.com
What is CAPM - Capital Asset Pricing Model - Formula, Example