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Problem - The country has tax rates as follows: corporate income tax of 36%, personal tax on regular income of 48%, personal tax on equity income of 30%. The company is currently unlevered and if management runs the company's operations optimally, then the company's value would be $140 million. However, under the current situation, if the company is profitable, then its operations will not be run optimally by management and this reduces its value by $40 million. If the company were to use $60 million of leverage, management would run the company's operations optimally no matter what. However, the leverage would cause the company's skilled employees to worry about their jobs and many employees would quit and seek employment elsewhere - this would have an expected cost to the company (in PV terms) of $50 million.
a. Assume the company is profitable, what would be the value of the company's equity under the levered capital structure?
b. Assume the company is not expected to be profitable for the foreseeable future, what would be the value of the company's equity under the levered capital structure?
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