How much will a firm need in cash flow before tax and interest to satisfy debtholders and equityholders if the tax rate is 35%,there is $13 million in common stock requiring a 10% return,and $6 million in bonds requiring a 6% return?

Question

Quizplus · Accepted Answer

First, we need to calculate the total return required by both equity and debt holders:

Equity: 10% of $13 million = $1.3 million
Debt: 6% of $6 million = $0.36 million

Total return required = $1.3 million + $0.36 million = $1.66 million

Now, we need to adjust for taxes by dividing the total return required by (1-tax rate):

Adjusted return = $1.66 million / (1-0.35) = $2.55 million

Finally, we add back the interest expense on the bonds:

Cash flow before tax and interest = $2.55 million + 0.06*$6 million = $2.91 million

Therefore, the firm will need $2.91 million in cash flow before tax and interest to satisfy debtholders and equityholders. However, this option is not given, and the closest answer is C ($2.36 million), which is the answer we choose.

How Much Will a Firm Need in Cash Flow Before