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1) The following are book and market value balance sheets of the United Frypan Company (figures in $ millions):
Book Value Balance SheetNet Working Capital $ 25 Debt $ 60Long Term Assets 75 Equity 40 =100 =100Market Value Balance SheetNet Working Capital $ 25 Debt $ 60Long Term Assets 180 Equity 145 =205 = 205
Assume that MM's theory holds except for taxes. There is no growth, and the $60 of debt is expected to be permanent. Assume a 21% corporate tax rate.
a. How much of the firm's market value is accounted for by the debt-generated tax shield?
b. What is United Frypan's after-tax WACC if rDebt = 6.7% and rEquity = 16.3%?
c. Now suppose that Congress passes a law that eliminates the deductibility of interest for tax purposes after a grace period of 5 years. What will be the new value of the firm, other things equal? Assume a borrowing rate of 6.7%
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