Here are book- and market-value balance sheets of the United Frypan Company (figures in $ millions): Book-Value Balance Sheet Net working capital $ 25 Debt $ 60 Long-term assets 75 Equity 40 $ 100 $ 100 Market-Value Balance Sheet Net working capital $ 25 Debt $ 60 Long-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? (Enter your answer in million rounded to 2 decimal places.) b. What is United Frypan’s after-tax WACC if rDebt = 6.7% and rEquity = 16.3%? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.) 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%. (Do not round intermediate calculations. Enter your answer in million rounded to 2 decimal places.)
Here are book- and market-value balance sheets of the United Frypan Company (figures in $ millions):
| Book-Value |
|||||
| Net working capital | $ | 25 | Debt | $ | 60 |
| Long-term assets | 75 | Equity | 40 | ||
| $ | 100 | $ | 100 | ||
| Market-Value Balance Sheet | |||||
| Net working capital | $ | 25 | Debt | $ | 60 |
| Long-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? (Enter your answer in million rounded to 2 decimal places.)
b. What is United Frypan’s after-tax WACC if rDebt = 6.7% and rEquity = 16.3%? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)
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%. (Do not round intermediate calculations. Enter your answer in million rounded to 2 decimal places.)
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