Question

Here are book- and market value balance sheets of the United Frypan Company (figures in $ millions): Book-Value Balance Sheet Net working capital $ 35 Debt Long-term assets 65 Equity $ 100 Market-Value Balance Sheet Net working capital $ 35 Debt Long-term assets 190 Equity $ 225 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 21% corporate tax rate. a. How much of the firm's market value is accounted for by the debt-generated tax shield? (Enter your answer in million rounded to 2 decimal places.) b. What is United Frypan's after-tax WACC I pebe 6.9% and reguit 16.1%? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.) 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 6.9% (Do not round Intermediate calculations. Enter your answer in million rounded to 2 decimal places.) PV tad milion WACC New value of the firm milion

Answer 1

are not abield - Debt x tax rate Part a: PV tax shield= Debt x tax rate (40*0.21) 8.40 Part b: WACC=rd*(1-t)*wd+re*we (0.069*(1-0.21)*(40/225))+0.161*(185/225) 14.21% Part c: PV tax shield= interest expense x tax rate x annuity factor (6.9%,5) 40*0.069*0.21*4.11120** 2.38 **factor working PVIFA(R%,n) |(1-(1+r)^-n)/ PVIFA(6.9%,5) (1-(1.0694-5)/0.069 4.11120 The total value of the firm falls by $8.40 ? $2.38 The total value of the firm = $225 ? $6.02 = 6.02 218.98