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Bubble Cloud Software House is an all equity firm that generates EBIT of $5 million per year in perpetuity. The cost of equity capital r0=18%, and its marginal tax rate, Tc, is 30%.
a) What is the market value of the firm?
b) Suppose Bubble Cloud now issues $10 million of 15% debt. (Assume debt is used to repurchase stock.) What will be the market value of the firm?
c) What will be the market value of the firm’s stock?
d) What is the return required by shareholders after debt financing?
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