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)