Question

Here are book- and market-value balance sheets of the United Frypan Company (figures in $ millions):

Book-Value Balance Sheet
Net working capital	$	45	Debt	$	45
Long-term assets		55	Equity		55
	$	100		$	100

Market-Value Balance Sheet
Net working capital	$	45	Debt	$	45
Long-term assets		200	Equity		200
	$	245		$	245

Assume that MM’s theory holds except for taxes. There is no growth, and the $45 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 r_Debt = 7.1% and r_Equity = 15.9%? (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 7.1%. (Do not round intermediate calculations. Enter your answer in million rounded to 2 decimal places.)

Answer 1