Question

Suppose the corporate tax rate is 40%. Consider a firm that earns $1000 before inter-est 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 5%.

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 $500 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?

Answer #1

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Suppose the corporate tax rate is 40 %. Consider a firm that
earns $ 1,000 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 4%. 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 the corporate tax rate is 40 %. Consider a firm that
earns $ 3 comma 000 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 8 %. a.
Suppose the firm has no debt and pays out its net income as a
dividend each year. What is the value of the...

Suppose the corporate tax rate is 35%. Consider a firm
that earns $3,000 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
4%.
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...

Suppose the corporate tax rate is 30 %. Consider a firm that
earns $ 1 comma 500 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 5 %.
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?...

Suppose the corporate tax rate is 35 %. Consider a firm that
earns $ 4 comma 000 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 7 %.
a. Suppose the firm has no debt and pays out its net income as a
dividend each year. What is the value of the...

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