Tax and Gearing

W22Extra Tax and Gearing More Questions Multiple Choice 1) Which of the following statements is false? A) In general, the gain to investors from the tax deductibility of interest ante upments is referred to as the interest tax shield. B) The interest tax shield is the additional amount that a firm would have paid in taxes if it did not have leverage. C) Because Corporations pay taxes on their profits after interest payments are deducted, interest expenditures reduce the amount of corporate tax firms must pay. D) As Modigliani and Miller made lite in their original work, capital social organization matters in perfect capital markets.Thus, if capital structure does not matter, then it must stem from a market imperfection. As Modigliani and Miller made clear in their original work, capital structure does not matter in perfect capital markets. Thus, if capital structure matters, then it must stem from a market imperfection. Rosewood Industries has EBIT of $450 meg, interest expens e of $175 cardinal, and a corporate tax rate of 35%. 2) Rosewoods take in income is close-hauled to A) $450 cardinal B) $180 cardinal C) $290 million D) $95 million Net income = (EBIT Interest expense)(1 ?C) = (450 175)(1 . 35) = $178. 75 3) The total of Rosewoods interlock income and interest payments is next to A) $270 million B) $355 million C) $290 million D) $450 million Net income + Interest = (EBIT Interest expense)(1 ? C) = (450 175)(1 . 35) = $178. 75 + $175 = $353. 73 4) If Rosewood had no interest expense, its net income would be enveloping(prenominal) to A) $405 million B) $160 million C) $450 million D) $290 million Net income = (EBIT Interest expense)(1 ? C) = (450 0)(1 . 35) = $292. 50 5) The amount of Rosewoods interest tax shield is closest to A) $115 million B) $290 millionC) $175 million D) $60 million Interest tax shield = Interest expense(? C) = 175(. 35) = $61. 25 Fly by Night Aviation (FBNA) expects to have net profit available for shareho lders next year of ? 24 million and Free Cash Flow of ? 27 million. FBNAs marginal corporate tax rate is 40%. 6) Establish FBNAs EBIT A) ? 43 million B) ? 40 Million C) ? 45 million D) ? 60 million EBIT = NI + Taxes + Interest expense FCF = NI + Interest expense = 27 = 24 + interest expense = 3 (EBIT Interest Expense)(1 0. ) = NI (EBIT 3)(0. 6) = 24 (EBIT 3) = 24/0. 6 = 40 EBIT = 40 + 3 = $43 7) IF FBNA increases leverage so that its interest expense rises by ? 1 million, then the amount its profit for shareholders will change is closest to A) -? 400,000 B) -? 600,000 C) ? 400,000 D) ? 600,000 (EBIT Interest Expense chg IE)(1 0. 4) = NI + chg NI (- chg IE)(0. 6) = chg NI -1m (. 6) = -600,000 Or, -$1m (1 . 4) = -$600,000 8) IF FBNA increases leverage so that its interest expense rises by ? 1 million, then the amount its Free Cash flow will change is closest to A) -? 600,000 B) -? 400,000C) ? 600,000 D) ? 400,000 FCF = NI + Interest expense chg FCF = chg NI + chg Interest expe nse = 600,000 + 1m = +400,000 Or, $1m (0. 4) = $400,000 LCMS Industries has ? 70 million in debt outstanding. The firm will pay only interest on this debt (the debt is perpetual). LCMS marginal tax rate is 35% and the firm pays a rate of 8% interest on its debt. 9) LCMS annual interest tax shield is closest to A) ? 2. 8 million B) ? 2. 0 million C) ? 3. 6 million D) ? 5. 6 million Annual Tax shield= annual debt interest ? C = ? 70M ? 0. 08 ? .35 = 1. 96M 10) take for granted that the risk is the same as the loan, the present value of LCMS interest tax shield is closest to A) ? 45. 5 million B) ? 20. 0 million C) ? 24. 5 million D) ? 35. 0 million PV of Tax shield = debt ? ?C = ? 70M ? .35 = 24. 5M 11) Assuming that the risk of the tax shield is only 6% even though the loan pays 8%, then the present value of LCMS interest tax shield is closest to A) ? 24. 5 million B) ? 18 million C) ? 33. 0 million D) ? $20. 0 million PV of Tax shield = debt ? ?C ? rD / rD2 = $70M ? .35 ? .08/. 0 6 = 32. 67