Here are book- and market-value
balance sheets of the United Frypan Company:
|
Book-Value
Balance Sheet
|
|||||
Net working capital
|
$
|
25
|
Debt
|
$
|
60
|
Long-term assets
|
75
|
Equity
|
40
|
||
$
|
100
|
$
|
100
|
||
Market-Value
Balance Sheet
|
|||||
Net working capital
|
$
|
25
|
Debt
|
$
|
60
|
Long-term assets
|
180
|
Equity
|
145
|
||
$
|
205
|
$
|
205
|
||
Assume that MM’s theory holds
except for taxes. There is no growth, and the $60 of debt is expected to be
permanent. Assume a 33% corporate tax rate.
|
a.
|
How much of the firm’s value is
accounted for by the debt-generated tax shield? (Round
your answer to 2 decimal places.)
|
PV tax shield
|
$
|
b.
|
What is United Frypan’s after-tax
WACC if rdebt = 6.7% and requity = 16.3%?
(Do not round intermediate calculations. Round
your answer to 2 decimal places.)
|
WACC
|
%
|
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 an 6.7% borrowing rate. (Do not
round intermediate calculations. Round your answer to 2 decimal places.)
|
New value of the firm
|
$
|
Explanation:
Some
values below may show as rounded for display purposes, though unrounded
numbers should be used for the actual calculations.
|
a.
|
PV tax shield = 0.33 × debt =
0.33 × $60 = $19.80
|
b.
 |
c.
|
Annual tax shield = 0.33 ×
interest expense = 0.33 × (0.067 × $60) = $1.33
|
PV tax shield = $1.33 × annuity
factor (6.7%, 5 years)
|
The total value of the firm falls
by $19.80 − $5.48 = $14.32.
|
The total value of the firm = $205
− $14.32 = $190.68.
|
