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Question - Premier Health System is just about to launch operations of a new oncology center. The oncology center will have book assets of $10 million, and it expects to earn a 16 percent return on these assets before taxes (EBIT = 14% x $10 million). The corporate tax rate is 40%. Management is trying to decide how to raise the required $10 million. It is known that the required rate of return for an all-equity firm in this business is 11 percent-that is, R(Reu) = 11%. Further, Premier can borrow at a rate of R(Rd) = 6%.
1. According to MM with taxes, what will be the value of Premier if it uses no debt? If it uses $6 million of 6 percent debt? If it uses $10 million of 6 percent debt?
2. What are the values of the CCC and R(Re) at debt levels of D=$0, D=$6 million, and D=$10 million, assuming a 40 percent corporate tax rate?
Use Excel in presenting the answers for your work. Be sure to show calculations (using cell formulas is suggested).
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