Submit Your Answer To Each Of The Problems And Show The Calc

Submit Your Answer To Each Of The Problems And Show The Calculations Y

Salinas Corporation has 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 in order 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%

Paper For Above instruction

Introduction

The evaluation of corporate financial strategies, including debt issuance, capital raising, and cost of equity, plays a pivotal role in determining a company's financial health and growth prospects. This paper addresses three specific problems: calculating the annual interest tax shield for Salinas Corporation, determining the number of shares Carbon8 Corporation must sell to raise a specific amount of capital considering various fees, and estimating FM Foods' after-tax cost of equity capital based on given market data. Each problem involves detailed financial calculations, reflecting real-world corporate financial decision-making processes.

Problem 1: Annual Interest Tax Shield for Salinas Corporation

Salinas Corporation's scenario involves understanding the benefit derived from its decision to take on debt. The interest tax shield is a tax-saving advantage resulting from interest deductions on debt, which reduces taxable income. The formula for the annual interest tax shield is:

Interest Tax Shield = Interest Expense × Tax Rate

First, calculate the interest expense:

Interest Expense = Debt Amount × Interest Rate = $20 million × 7% = $1.4 million

Next, calculate the tax shield:

Tax Rate = 40%

Interest Tax Shield = $1.4 million × 40% = $0.56 million

Thus, the annual interest tax shield that Salinas Corporation would realize if it proceeds with the debt issuance is $560,000.

Problem 2: Number of Shares Carbon8 Must Sell

Carbon8 aims to raise $120 million net of fees through a seasoned equity offering. The company’s stock is priced at $28.00 per share, but the underwriters demand a fee of $1.25 per share, and the offering must be underpriced by 7.5%. Additionally, legal and administrative costs amount to $785,000. The goal is to determine how many shares need to be sold to net the desired amount after all costs and fees.

Starting with the calculation of the gross proceeds needed:

Net amount desired = $120 million

Total fees per share = Underwriter fee + Underpricing premium + Legal/administrative costs allocated per share

Firstly, find the price at which shares will be offered considering underpricing:

Offer price per share = Current stock price × (1 - Underpricing percentage)

= $28.00 × (1 - 0.075) = $28.00 × 0.925 = $25.90

Calculate the total fee per share:

Underwriter fee = $1.25

Legal and administrative costs = $785,000 (cost spread over total shares issued, to be determined)

Since the legal costs are fixed, they are added to the total amount needed to be raised.

Next, determine the number of shares (N) to be issued:

Total proceeds after fees should equal $120 million, so:

Proceeds = N × Offer price per share - Total fees and costs

Rearranged to get N:

N = (Desired net amount + total fixed costs) / (Offer price per share - per-share fees)

Assuming the legal costs are spread over the number of shares issued, we set:

Total fixed costs = $785,000

Per-share cost component = $1.25 (underwriter fee) + ($785,000 / N)

Thus:

N = ($120,000,000 + $785,000) / (25.90 - 1.25 - (785,000 / N))

This results in an implicit equation that can be simplified by approximation. Using approximation, neglecting (785,000 / N) initially, then refining:

N ≈ ($120,000,000 + $785,000) / (25.90 - 1.25) = $120,785,000 / 24.65 ≈ 4,902,497 shares

Now, considering the fixed legal cost, total costs:

Total fixed costs = $785,000

Total proceeds needed = $120 million + $785,000 = $120,785,000

Number of shares: N = Total proceeds / (offer price - fee per share) ≈ $120,785,000 / (24.65) ≈ 4,902,497 shares

Therefore, Carbon8 must sell approximately 4.9 million shares to raise the required capital net of all fees and costs.

Problem 3: FM Foods’ After-Tax Cost of Equity Capital

Estimating the cost of equity involves utilizing the Capital Asset Pricing Model (CAPM) and market data. The formula for the cost of equity (Re) is:

Re = Risk-Free Rate + Beta × Market Risk Premium

The risk-free rate is given as the yield on long-term government bonds: 4.4%. The equity beta for FM Foods is 1.20, and the historical market risk premium is 6.5%. Therefore:

Re = 4.4% + 1.20 × 6.5% = 4.4% + 7.8% = 12.2%

Alternatively, considering the company's specific circumstances, adjusting for beta and market conditions, the expected return remains around 12.2% as an estimate of the before-tax cost of equity.

Since the question asks for the after-tax cost, and noting that the cost of equity is unaffected by corporate taxes (as interest is tax-deductible, but equity isn't), the after-tax cost of equity remains approximately 12.2%, because taxes tend to affect debt costs more directly.

For completeness, if considering the weighted average cost of capital (WACC), incorporating debt costs after tax, the calculation would factor in the company's debt and equity proportions and tax rate, but for pure cost of equity, the CAPM estimate suffices.

Conclusion

This analysis highlights key financial decision metrics for firms, including tax shields from debt, issuance costs for equity, and the cost of equity capital based on market data. Salinas's interest tax shield effectively reduces taxable income, providing nearly half a million dollars annually. Carbon8's capital raising requires a substantial number of shares due to fees and underpricing, emphasizing the importance of precise calculations in equity issuance. FM Foods' estimated after-tax cost of equity, approximately 12.2%, serves as a vital input in assessing its overall cost of capital and investment decisions, illustrating the interconnectedness of market data and corporate finance strategy.

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