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The Nexxt Co. is reviewing its capital structure. The firm currently has no debt outstanding. The firm has an EBIT of $150,000 per year, which is expected to stay constant forever. The marginal corporate tax rate is 35%. The expected return on the firm's assets is 15%. The firm is considering whether it would be worthwhile to raise $500,000 of debt with a bond issue at 10%, to be sold at par. The proceeds of the issue would be paid out in the form of a dividend to the firm's 10,000 shareholders.
Problem a. What is the value of the firm if recapitalized, assuming the debt issued will be outstanding indefinitely?
Problem b. What is the value of the firm's equity under the recapitalization plan?
Problem c. What is the expected return on equity if the firm recapitalizes?
Problem d. Compute the firm's weighted average cost of capital after the recap
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