Here is the market value of the United Frypan Company: VD_o = $40.00 (Value of D
ID: 2769692 • Letter: H
Question
Here is the market value of the United Frypan Company: VD_o = $40.00 (Value of Debt) VE_o= S120.00 (Value of Equity) The tax rate is 40 percent and interest is tax deductible. The company is a perpetual steady state company. Currently the debt is yielding 8 percent. How much of the firm's value is accounted for by the debt generated subsidy? How much better off will UF's shareholders be if the firm borrows $20 more and uses it to repurchase stock? The interest rate will be 10 percent with this higher debt level. Now suppose that Congress passes a law which will phase out the deductibility of interest for tax purposes after a period of 5 years. What will the new value of the firm be; all other things remaining equal.Explanation / Answer
Answer:a PV tax shield = 0.40 × debt = 0.40 × $40 = $16
Answer:c
Annual tax shield = 0.40 × interest expense = 0.40 × (0.08 × $40) = $1.28
PV tax shield = $1.28 × annuity factor (8%, 5 years)
=1.28*3.9927= 5.11
The total value of the firm falls by $16 $5.11 = $10.89
The total value of the firm = $160 $10.89 = $149.11
The total value of the firm falls by $16 $5.11 = $10.89
The total value of the firm = $160 $10.89 = $149.11