Accounted for by the debt-generated tax shield

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Reference no: EM132057281

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

Book-Value Balance Sheet

Net working capital $ 40 Debt $ 60

Long-term assets 60 Equity 40

$ 100 $ 100

Market-Value Balance Sheet

Net working capital $ 40 Debt $ 60

Long-term assets 180 Equity 160

$ 220 $ 220

Assume that MM’s theory holds except for taxes. There is no growth, and the $60 of debt is expected to be permanent. Assume a 30% 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 rDebt = 7.6% and rEquity = 15.4%? (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. What will be the new value of the firm, other things equal? Assume a borrowing rate of 7.6%. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Reference no: EM132057281

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