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Question 6 (14 marks) a) You, as an Australian resident, hold shares in FIN222 Ltd which you purchased 2 years ago for $30 per share. They are now selling for $37 per share. You have a marginal tax rate of 37% while the corporate tax rate is 30%. Under the imputation tax system, would you prefer to receive $7 special dividends or sell the shares and benefit from capital gains? Show all your workings. (7 marks) b) FIN222 Ltd carries $30 million in debt. The market value of debt matches its book value of $30 million. The firm expects to generate $15 million per year in free cash flows next year and these free cash flows are expected to grow at 4% per year in perpetuity. Each year, FIN222 Ltd is expected to pay out 60% of its free cash flows as dividends. The cost of debt is 9% before tax and the cost of equity to the firm is 13%. Corporate tax rate is 30%. Assume that investors can utilise 70% of the franking credits paid by the firm. i) Assume a classical tax system and calculate the market value of equity. (1 mark) ii) Assume a classical tax system and calculate the WACC. (2 marks) iii) Assume an imputation tax system and calculate the market value of equity. (2 marks) iv) Assume an imputation tax system and calculate the WACC. (2 marks) Question 6 (14 marks) a) You, as an Australian resident, hold shares in FIN222 Ltd which you purchased 2 years ago for $30 per share. They are now selling for $37 per share. You have a marginal tax rate of 37% while the corporate tax rate is 30%. Under the imputation tax system, would you prefer to receive $7 special dividends or sell the shares and benefit from capital gains? Show all your workings. (7 marks) b) FIN222 Ltd carries $30 million in debt. The market value of debt matches its book value of $30 million. The firm expects to generate $15 million per year in free cash flows next year and these free cash flows are expected to grow at 4% per year in perpetuity. Each year, FIN222 Ltd is expected to pay out 60% of its free cash flows as dividends. The cost of debt is 9% before tax and the cost of equity to the firm is 13%. Corporate tax rate is 30%. Assume that investors can utilise 70% of the franking credits paid by the firm. i) Assume a classical tax system and calculate the market value of equity. (1 mark) ii) Assume a classical tax system and calculate the WACC. (2 marks) iii) Assume an imputation tax system and calculate the market value of equity. (2 marks) iv) Assume an imputation tax system and calculate the WACC. (2 marks)

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