10.00 points Here are book and market value balance sheets of the United Frypan

Question

10.00 points Here are book and market value balance sheets of the United Frypan Company (UF) Book Net working capital Long-term assets 80 100 Debt 120 140 Equity $220 $220 Market Net working capital 80 Long-term assets 200 100 Debt 180 Equity 180 $280 $280 Assume that MM's theory holds with taxes. There is no growth, and the $100 of debt is expected to be permanent. Assume a 35% corporate tax rate. a. How much of the firm's value is accounted for by the debt-generated tax shield? PV tax shield b. How much beter off will F' shareholders be if the firm borrows $80 more and uses it to repurchase stock? Increase in debt $ References eBook&Resources; Worksheet Difficulty: Basic Check my work c2016 McGraw-Hill Education. All rights reserved

Explanation / Answer

Question 1:

Part a)

PV of tax shield = Amount of debt x tax rate

                                = 100 x 35%

                                = 35

Part b)

Additional tax shield = 80 x 35%

                                         = 28

Therefore, borrowing additional 80 dollars will increase the value of firm by 28 dollars.

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