3. ABC Inc. is an unlevered firm. The current required return on the firms equity is 15%. The current EBIT is $3 million and remains constant forever hereafter. The firm is planning a recapitalization under which it will issue $5 million of perpetual 8% debt and use the proceeds to buy back shares. The tax rate is 40%

Required:

a) Calculate the value of the firm before the recapitalization plan is announced.

b) Calculate the value of the firm after the recapitalization plan is announced.

In the end of year 5, the firm changes its capital structure as a target debt-equity ratio 40%.

(Using this additional information to answer the following questions)

c) Assume the cost of debt is remain 8%, what is the weighted average cost of capital?

d) What is the value of the firm in year 5?

e) What is the value of the firm now?