Chapter 18, Problem 15P

Remex (RMX) currently has no debt in its capital structure. The beta of its equity is 1.50. For each year into the indefinite future, Remex’s free cash flow is expected to equal $25 million. Remex is considering changing its capital structure by issuing debt and using the proceeds to buy back stock. It will do so in such a way that it will have a 30% debt-equity ratio after the change, and it will maintain this debt-equity ratio forever. Assume that Remex’s debt cost of capital will be 6.5%. Remex faces a corporate tax rate of 35%. Except for the corporate tax rate of 35%, there are no market imperfections. Assume that the CAPM holds, the risk-free rate of interest is 5%, and the expected return on the market is 11%.

1. a. Using the information provided, complete the following table:

1. b. Using the information provided and your calculations in part a, determine the value of the tax shield acquired by Remex if it changes its capital structure in the way it is considering.