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What is the present value of the firm

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An all-equity financed firm currently has EBIT of $10,000. EBIT is expected to stay at this level for 10 years. After that, the firm will cease operation. The firm's corporate tax rate is 35 percent. The discount rate of this firm is 12 percent.

(a) What is the present value of the firm?

(b) Now assume the firm issues $25,000 of debt paying interest of 8 percent per year, using the proceeds to retire equity. The debt is also expected to be mature in 10 years. What is the total value of the firm?

(c) The debt issue raises the probability of bankruptcy. The firm has a 25 percent chance of going bankrupt after 5 years. If it does go bankrupt, it will incur bankruptcy costs of $30,000. The discount rate is still assumed to be 12 percent. Should the firm issue the debt? Please explain the reason.

Reference no: EM133113231

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