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1) What is the after-tax cost of debt for a firm that has a 10
1)
What is the after-tax cost of debt for a firm that has a 10.5% yield to maturity on its bonds if the interest subsidy tax rate is 20%? (express as a percentage without a percent sign rounded to a single decimal place)
2)
Your friend offers to pay you an annuity of $6,100 at the end of each year for 3 years in return for cash today. You could earn 5.5% on your money in other investments with equal risk. What is the most you should pay for the annuity?
3)
Dynamo Company produces annual cash flows of $150 and is expected to exist forever. The company is currently financed with 75 per cent equity and 25 per cent debt. Your analysis tells you that the appropriate discount rates are 10 per cent for the cash flows, and 7 per cent for the debt. You currently own 10 per cent of the shares. M&M Proposition 1: How much is Dynamo worth today?
Expert Solution
1)
Computation of After-tax Cost of Debt:
After-tax Cost of Debt = Yield to Maturity * (1-Tax Rate)
= 10.5%*(1-20%)
After-tax Cost of Debt = 8.4%
2)
Computation of Present Value of Annuity using PV Function in Excel:
=-pv(rate,nper,pmt,fv)
Here,
PV = Present Value of Annuity = ?
Rate = 5.5%
Nper = 3 years
PMT = $6,100
FV = 0
Substituting the values in formula:
=-pv(5.5%,3,6100,0)
PV or Present Value of Annuity = $16,457.39
3)
Computation of Dynamo Worth Today:
Dynamo Worth Today = Annual Cash Flows/Discount Rate
= $150 million / 10%
Dynamo Worth Today = $1,500 millions
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