Question

Here are book- and market-value balance sheets of the United Frypan Company:

Book-Value Balance Sheet
Net working capital	$	35	Debt	$	40
Long-term assets		65	Equity		60
	$	100		$	100

Market-Value Balance Sheet
Net working capital	$	35	Debt	$	40
Long-term assets		190	Equity		185
	$	225		$	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 37% corporate tax rate.

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

b. What is United Frypan’s after-tax WACC if r_Debt = 6.9% and r_Equity = 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. Round your answer to 2 decimal places.)

Answer 1