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How much of the firm value is accounted for by the debt

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Reference no: EM131140407

Here is the market value of the United Frypan Company:

VDO = $40.00

VEO = $120.00

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.

a. How much of the firm's value is accounted for by the debt generated subsidy? (7 points)

b. How much better off will UF is a shareholder 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. (7 points)

c. 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? (6 points)

Reference no: EM131140407

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