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Consider a firm that lasts 5 years and earns revenues of $1000K per year (years 1-5) after an initial investment of $1500K in year 0. The firm faces a tax rate of 10% per year.
a) Assume that the firm carries no debt, and faces a cost of equity of 12%. What is the unlevered value of the firm?
b) Assume that the firm issues 5-year debt with face value $1000K. If the coupon rate is 5% and yield to maturity is 5%, what is the market value of debt?
c) Find the present value of the interest tax shield.
d) Use the information in b) and c) to find the value of the levered firm and the implied market value of equity.
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Which do you think is more risky for a firm trying to raise capital - an underwritten offering or a best-efforts offering?
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