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Debt-generated tax shield

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Here are book and market value balance sheets of JARAMA. Book (euros) Net working capital 40 Debt 80 Long term assets 160 Equity 120 200 200 Market (euros) Net working capital 40 Debt 80 Long term assets 240 Equity 200 280 280 Assume that MM's theory holds with taxes. There is no growth, and the level of debt is expected to be permanent. Assume a 30% corporate tax rate.

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

b. How much better off will be Jarama's shareholders be if the firm borrows €40 more and uses it to repurchase stock?

Reference no: EM132758171

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