2.

A. Modigliani and Miller's world of no taxes.

Roxy Broadcasting, Inc. is currently a low-levered firm with a debt-to-equity ratio of 1/9.

The company wants to increase its leverage to 9/1 for debt to equity. If the current return on assets is 10% and the cost of debt is 8%, what are the current and the new costs of equity if Roxy operates in a world of no taxes?

B. Roxy Broadcasting was originally an all-equity firm with a before-tax value of $15,000,000.

Roxy now pays taxes at a 35% rate. What is the value of Roxy under the 45/55 debt-to-equity capital structure? Under the 55/45 capital structure?

C. Roxy Broadcasting was originally an all-equity firm with a before-tax value of $20,000,000.

Determine the size of the tax shield with a corporate tax rate of 10%, 26%, 36%, and 46% if Roxy's capital structure is 35/65 debt to equity. Determine the same if the capital structure is 65/35.

3.

Air Seattle has an annual EBIT of $1,600,000, and the WACC in the unlevered firm is 18%. The current tax rate is 20%. Air Seattle will have the same EBIT forever. If the company sells debt for $2,300,000 with a cost of debt of 23%, what is the value of equity in the unlevered firm and in the levered firm? What is the value of debt in the levered firm? What is the government's value in the unlevered firm and in the levered firm?