Smoke and Mirrors has EBIT of 25000 and is all equity financed. EBIT is expected to stay at this level indefinitely. the firm pays corporate taxes equal to 35% of taxable income. The discount rate for the firm's project is 10 percent.

(a) What is the market value?

(b) Now assume the firm issues 50000 of debt paying interest of 6% per year and uses the proceeds to retire equity. The debt is expected to be permanent. What will happen to the total value of the firm?

(c) Re-compute your answer to part (b), under the following assumptions, the debt issue raises the possibility of bankruptcy; the firm has a 30% chance of going bankrupt after 3 years; if it does go bankrupt, it will incur bankruptcy costs of 200,000. The discount rate is 10% should the firm issue the debt?