Question 48 ABC Products needs to replace its rawhide tanning and molding equipm

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Question 48

ABC Products needs to replace its rawhide tanning and molding equipment. It can be used for five years and will have no salvage value. The equipment costs $930,000. The firm can lease it for $245,000 a year, or it can borrow the money to purchase the equipment at 7%. The firm's tax rate is 40%. The CCA rate is 20% (Class 8).What is the present value of the depreciation tax shield?

Select one:

a. $336,959

b. $377,177

c. 301,242

d. $343,885

e. $351,193

Question 49

Al's Audio has a cost of debt of 7 percent, a cost of equity of 12 percent, and a cost of preferred stock of 9 percent. The weight for debt is 0.16, the weight for preferred shares is 0.34, and the weight for common stock is 0.5. The company's tax rate is 34 percent. What is the weighted average cost of capital for Al's Audio Shop?

Select one:

a. 9.45 percent

b. 9.68 percent

c. 9.15 percent

d. 9.80 percent

e. 6.54 percent

Question 50

Ernst's Electrical has a bond issue outstanding with ten years to maturity. These bonds have a $1,000 face value, a 5 percent coupon, and pay interest annually. The bonds are currently quoted at 90 percent of face value. What is Ernst's pre-tax cost of debt?

Select one:

a. 6.38 percent

b. 6.47 percent

c. 5.33 percent

d. 5.53 percent

e. 5.40 percent

Explanation / Answer

(48) Cost of Debt = 7 % , Tax Rate = t = 40 %, Equipment Cost = C = $ 930000, CCA Depreciation Rate = d = 20 %

Discount Rate = After-Tax Cost of Debt =k = 7 x (1-0.4) = 4.2 %

PV of CCA Tax Shield = [C x d x t / (k+d)] x [1+k/2 / 1+k] = [930000 x 0.2 x 0.4 / (0.042 + 0.2)] x [1.021/1.042] = $ 301242.05 or $ 301242 approximately.

Hence, the correct option is (c).

NOTE: Please raise separate queries for solutions to the remaining unrelated questions.

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