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Question
Here are book and market value balance sheets of the United Frypan Company (UF):
Book Value Balance
SheetNet working capital $30 $50
DebtLong-term assets 90 70
Equity $120 $120
Market Value Balance Sheet
Net working capital $30 $50
DebtLong-term assets 150 130
Equity $180 $180
Assume that MM's theory holds with taxes. There is no growth, and the $50 of debt is expected to be permanent. Assume a 40% corporate tax rate.
a. How much of the firm's value is accounted for by the debt-generated tax shield?
PV tax shield $
b. How much better off will UF's shareholders be if the firm borrows $30 more and uses it to repurchase stock?
Increase in equity value $
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