Q1 Let the crossover EBIT be x

Issuing Equity Issuing Debt

EBIT x x
Less: Interest Expense 50 71
Less: Taxes = PAT (x-50)(1-.34) (x-71)(1-.34)
EPS (x-50)(1-.34)/95…....(i) (x-71)(1-.34)/80…....(ii)
Solving (i) and (ii), we get x as $183m

Q2 Ms Kraft owns $100,000/$16,000,000=0.00625 of Copperhead’s equity

To receive exactly the same profits as before, she has to
a.Borrow 0.00625 x $1m = $6,250 and
b.Buy $6,250 (= 3,125 shares at $2) of more commonstock of Copperhead to maintain the equitypercentage

Q3 Rs = Ro + B/S (Ro - Rb)

Ro = 50/80*16%+30/80*8% 0.13
Rs = .13 + 20/60(.13- 0.08) 14.67%

Q4 a True. MM Propositions have few assumptions and among them one of them
b True. As long as the return earned by the company is greater than the interes
c False. The cost of equity increases with the ratio D/E.
d False. As the debt in the capital structure increases, the cost of borrowing wi
e False. Borrowing does increase the financial risk and cost of equity. Leverag
f False. MM theory says that the borrowing does not affect the value of firm, h

Q5 Step 1 The value of the both the firms is equal and each of their value is represented
To purchase one percent of Company B's equity (0.009V) and the company
0.01 x (DA - DB) = 0.002 V
This investment requires a net cash outlay of (0.007 V) and it provides a net
(0.01 x Profits) - (0.003 × rf × V)
Here rf is the risk-free rate of interest on debt. And therefore the two investm

Step 2 In this case the company can buy two percent of company A's investment an
0.02 x (DA DB) = 0.004 V
This investment requires a net cash outlay of (0.018 V) and provides a net ca
(0.02 × Profits) – (0.002 × rf × V)
Therefore the two investments are identical.

Step 3 The expected dollars return to company's original investment in A is:

(0.01 × C) (0.003 × rƒ × V₁)
Here C = Expected profit (cash flow) generated by the firm's assets.
As the firms are the same except for capital structure, C must also be the exp
 The dollar return to company's alternative strategy is:
(0.01 x C) (0.003 × If × VB)
Also, the cost of the original strategy is (0.007VA) while the cost of the alter
In the event of the value of company A is less than the value of company B,

Q6
A. Stock price remains same , market price of stock not affected by the anno
Because Market price of stock affected by return on investments etc.

B. Market price of shares = $14 company can buy back the

210/14= 15 million

C. Market value of Firm = Equity + Debt

Equity = (27 million - 15 million ) × 14 = 168 million
Market value of debt = 168 +210= 378 million
Market value of Firm unchanged

D. Debt ratio = Debt /(debt +equity) = 210/378= 0.55

E. No gain or loses because market value of Firm and price unchanged.

Q7
a. Value of Equity = 550 Million
Value of Debt = 200 million

WACC 10.0133333333333

b. In this case the WACC would be same as cost of equity i.e. 12%. It would be

Q8
a. Relative Tax Advantage of Corporate Debt = (1-Tp)/((1-Tpe)(1-Tc)

b. Relative Tax Advantage of Corporate Debt = (1-Tp)/((1-Tpe)(1-Tc)

n the equitypercentage at $106250/$17 million=0.00625

ong them one of them says that there are no taxes and there is symmetry of information.
reater than the interest payment, earnings per share increase, but the P Falls to reflect the higher risk.

cost of borrowing will increase and so will the financial distress cost. The cost of equity also increases as the debt level increase
ost of equity. Leverage in the capital structure magnifies the return on equity. Profits and Losses will also be maginified
ect the value of firm, however it says that the corporate borrowing increases earning per share as long as rate of return is greater

ir value is represented by V.
9V) and the company borrows an amount equal to:

and it provides a net cash return of:

refore the two investments are identical.

any A's investment and lend an amount equal to:

and provides a net cash return of:

stment in A is:

firm's assets.
C must also be the expected cash flow for Firm B.
ile the cost of the alternative strategy is (0.007VB)
value of company B, the original strategy of investing in company A results in not only less cost but also a larger dollar return. T

t affected by the announcement.

vestments etc.

price unchanged.

y i.e. 12%. It would be higher by almost 2%

1-Tpe)(1-Tc)
= (1-0.35)/((1-0)*(1-0.39))
1.065574

1-Tpe)(1-Tc)
= (1-0.35)/((1-0.15)*(1-0.39))
1.253616
 s as the debt level increases
also be maginified
as rate of return is greater than the interest paid
also a larger dollar return. Therefore no rational investor will be willing to invest in company B if its value is higher than the com
alue is higher than the company A.