Corporate Finance: Timpano Inc. can each period have good sales with 50% probabi
ID: 2417054 • Letter: C
Question
Corporate Finance:
Timpano Inc. can each period have good sales with 50% probability or bad sales with 50% probability. In case of good sales the unlevered cash flow will be $80 million, in case of bad sales the unlevered cash flow will be $50 million. The unlevered beta of the company is 1.5, the expected return of the market portfolio is 4% while the risk-free return is 1%. Timpano's equity market value is $850 million and its debt is kept constant at $950 million.
What is the corporate tax rate? (Assume that the firm's cash flow is perpetual).
Answer: 65.07%. (Its a past paper that I am trying to solve. So I had the answer. The purpose of posting the answer is to get the calculations, as I could not reach the answer.)
Explanation / Answer
unlevered cash flow = .5*80 +.5*50 = 65
cost of equity = IRF + (RISK PREMIUM)*BETA
1% + (3)1.5 = 5.5%
VALUE OF EQUITY = NI / Ke
850 = NI / 5.5%
NI = 850*.055 = 46.75
NET OPERATING INCOME - TAX = NET INCOME
65 - TAX = 46.75
TAX = 65 - 46.76 = 18.25
TAX RATE = 18.25/65 = .28076*100 = 28.07%
THIS IS THE CORRECT SOLOUTION