Suppose the corporate tax rate is 40%. Consider a firm that earns $4,500 in earnings before interest and taxes each year with no risk. The firm's capital expenditures equal its depreciation expenses each year, and it will have no changes to its net working capital. The risk-free interest rate is 6%. a. Suppose the firm has no debt and pays out its net income as a dividend each year. What is the value of the firm's equity? b. Suppose instead the firm makes interest payments of $2,000 per year. What is the value of equity? What is the value of debt? c. What is the difference between the total value of the firm with leverage and without leverage?

Suppose the corporate tax rate is 40%. Consider a firm that earns $4,500 in earnings before interest and taxes each year with no risk. The firm's capital expenditures equal its depreciation expenses each year, and it will have no changes to its net working capital. The risk-free interest rate is 6%. a. Suppose the firm has no debt and pays out its net income as a dividend each year. What is the value of the firm's equity? b. Suppose instead the firm makes interest payments of $2,000 per year. What is the value of equity? What is the value of debt? c. What is the difference between the total value of the firm with leverage and without leverage?

Intermediate Financial Management (MindTap Course List)

13th Edition

ISBN:9781337395083

Author:Eugene F. Brigham, Phillip R. Daves

Publisher:Eugene F. Brigham, Phillip R. Daves

Chapter17: Dynamic Capital Structures And Corporate Valuation

Section: Chapter Questions

Problem 3P

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Question

Ef 314.

Suppose the corporate tax rate is 40%. Consider a firm that earns $4,500 in earnings before interest and taxes
each year with no risk. The firm's capital expenditures equal its depreciation expenses each year, and it will
have no changes to its net working capital. The risk-free interest rate is 6%.
a. Suppose the firm has no debt and pays out its net income as a dividend each year. What is the value of the
firm's equity?
b. Suppose instead the firm makes interest payments of $2,000 per year. What is the value of equity? What is
the value of debt?
c. What is the difference between the total value of the firm with leverage and without leverage?
d. To what percentage of the value of the debt is the difference in part (c) equal?

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