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3 . A firm has a book value of equity of $ 1 2 0 million and no debt. The company is in a 2
A firm has a book value of equity of $ million and no debt. The company is in a tax bracket and
has an EBIT of $ million.
a What is the net income of the firm if it issues $ million debt at interest rate to buy back its stocks?
Show calculations.
b What is the net income of the company when there is no debt? Show calculations.
c Assuming that all net income is distributed as dividend and this amount is expected to remain constant
forever, what is the market price of equity after issuing the debt? Assume cost of equity to be
after issuing debt.
d Assuming that all net income is distributed as dividend and the net income is expected to remain
constant forever, what is the market price of equity when there is no debt? Assume cost of equity to be
e What is the total value of equity and debt of the firm with debt?
f What is the WACC of the firm with debt?
g What is the tax savings per year when debt is issued vs when there is no debt?
h What is the present value of tax savings assuming that the income statement remains the same forever?
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