Question

Question 111 (25 marks) The Chicago Delivery Inc. is an all equity firm. The company's CFO is forecasting the following economic scenarios for the firm's cash flow before taxes. All cash flows are expected to be level perpetuities Recession 25,000,000 (40%) Normal 50,000,000 (40%) Expansion 100,000,000 (20%) EBIT (Probability) The company's cost of equity capital is calculated to be 10%. The company's CFO is recommending issuing $80,000,000 of debt to repurchase shares outstanding. Corporate tax rate is 40%. Using the above information, answer the following questions. After issuing debt, the company president uses the Miller and Modigliani's 1963 proposition (corporate taxes) to calculate the value of the company. What is the company's total market value under this scenario? a) b) The CFO does not agree with the president's valuation. She contends that Miller and Modigliani's 1963 proposition is not realistic. She believes the company's total market value after the new debt issuance is much less at approximately $315 million. Discuss what explains the difference between the president's and the CFO's approaches?

Answer 1

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