Assume that MM’s theory holds except for taxes. There is no growth, and the $40

Question

Assume that MM’s theory holds except for taxes. There is no growth, and the $40 of debt is expected to be permanent. Assume a 35% corporate tax rate.

How much of the firm's market value is accounted for by the debt-generated tax shield?

What is United Frypan’s after-tax WACC if rDebt = 8% and rEquity = 15%? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Now suppose that Congress passes a law that eliminates the deductibility of interest for tax purposes after a grace period of 5 years. What will be the new value of the firm, other things equal? Assume a borrowing rate of 8%. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Explanation / Answer

a)How much of the firm's market value is accounted for by the debt-generated tax shield?

Ans) PV of Tax Shieid = Tax Sheild/WACC

= (40*0.35)/WACC

(WACC not given.)

..

.

b. What is United Frypan’s after-tax WACC if rDebt = 8% and rEquity = 15%?

Ans) After Tax cost of debt = 8*0.65

= 5.2%

WACC = 5.2*([40/(40+120)] + 15*[120/(40+120)]

= 5.2*0.25 + 15*0.75

= 12.55%

..

..

c)Now suppose that Congress passes a law that eliminates the deductibility of interest for tax purposes after a grace period of 5 years. What will be the new value of the firm, other things equal? Assume a borrowing rate of 8%.

Ans)Value of Firm will remian same. Since Net Opearting Incomw will not change due a law that eliminates the deductibility of interest for tax purposes after a grace period of 5 years

Market Value of Firm = NOI/WACC

Cost of Equity = 15%

.

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.