Taxes and the Cost of Capital. Here are book- and market-value balance sheets of

Question

Taxes and the Cost of Capital. Here are book- and market-value balance sheets of the United Frypan Company (figures in $millions) BOOK-VALUE BALANCE SHEET Net working capltal Long-term assets $ 20 80 $100 Debt Equity S 40 60 $100 MARKET-VALUE BALANCE SHEET Net working capital Long-term assets $ 20 140 $160 Debt Equity S 40 120 $160 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 a. How much of the firm's value is accounted for by the debt-generated tax shield?

Explanation / Answer

Using Modiglani Miller's theory we know that Present value of debt generated tax shiled=Tax rate*Permanent Debt=35%*40=$14

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