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In unlevered (all-equity) firm has expected earnings (EBIT) of $33,062.50 and an expected return (R0) of 11.5 percent. The firm is planning to issue $50,000 of debt at 7 percent interest and use the proceeds to repurchase shares at their current market value. Assume that expected earnings and interest payments are constant and perpetual.
Problem a. Suppose there are no taxes. What will be the firm value, cost of equity, and cost of capital after the repurchase?
Problem b. Suppose that the government imposes a 35 percent corporate tax rate for the first time and all other variables are the same. What will be the firm value, cost of equity, and cost of capital after the repurchase?
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