Air Tampa has just been incorporated, and its board of directors is grappling with the question of optimal capital structure. The company plans to offer commuter air services between Tampa and smaller surrounding cities. Jaxair has been around for a few years, and it has about the same basic business risk as Air Tampa would have. Jaxair's market-determined beta is 1.9, and it has a current market value debt ratio (total debt to total assets) of 60% and a federal-plus-state tax rate of 35%. Air Tampa expects to be only marginally profitable at start-up; hence its tax rate would only be 30%. Air Tampa's owners expect that the total book and market value of the firm's stock, if it uses zero debt, would be $12 million. Air Tampa's CFO believes that the MM and Hamada formulas for the value of a levered firm and the levered firm's cost of capital should be used because zero growth is expected. (These are given in equations VL = VU + VTax shield = VU + TD, rsL = rsU + (rsU - rd)(1 - T)(D/S), and b = bU[1 + (1 - T)(D/S)].)

a. Estimate the beta of an unlevered firm in the commuter airline business based on Jaxair's market-determined beta. (Hint: This is a levered beta; use Equation b = bU[1 + (1 - T)(D/S)] and solve for bU.) Do not round intermediate calculations. Round your answer to three decimal places.

b. Now assume that rd = rRF = 10% and that the market risk premium RPM = 4%. Find the required rate of return on equity for an unlevered commuter airline. Do not round intermediate calculations. Round your answer to three decimal places.

c. Air Tampa is considering three capital structures: (1) $2 million debt, (2) $4 million debt, and (3) $6 million debt. Estimate Air Tampa's rs for these debt levels. Do not round intermediate calculations. Round your answers to two decimal places.

1. Air Tampa's rs for $2 million debt: %
   
   
2. Air Tampa's rs for $4 million debt: %
   
   
3. Air Tampa's rs for $6 million debt: %

d. Calculate Air Tampa's rs at $6 million debt while assuming its federal-plus-state tax rate is now 40%. (Hint: The increase in the tax rate causes VU to drop to $10.285714 million.) Do not round intermediate calculations. Round your answer to two decimal places. Compare this with your corresponding answer to part

1. Higher tax rate (keeps the same/ increases/ reduces) the financial risk premium at a given market value debt/equity ratio.

THANK YOU

Ale Tampa has just been incorporated, and its board of directors is grappling with the question of optimal capital structure. The company plans to offer commuter www tamen surrounding cities. Jaxcale has been around for a few years, and it has about the same basic business viskas ir Tumpe would have war's market det med beta i t. sed has a current debt ratio (total debt to total assets) of 60 and a federal-plus-state tax rate of 35%. Air Tumpa expects to be only wally profitable startence is taken to an owners expect that the total book and market value of the firm's stock, it was more det, would be $12 million Air Tableves that the formules to the and the levered firm's cost of capital should be used because 2e growth is expected. These are given in ons - Vy+V+ 0,0%) (0/5)1.) a. Estimate the beta of an unlevered firm in the commuter aline business based on Jaar's market determined betart: This is a severed base on it-Torsland for bye) Do not round Intermediate calculations. Round your answer to three decimal places b. Now assume that ? - Tu 10% and that the market risk premium RP - 44. Find the required rate of return on equity for an unleveret commar tine. Do not rund um die calculations. Round your answer to three decimal places. c. Air Tampa is considering three capital structures (1) $2 million debt. (2) 4 million debt, and () $6 milion debt. Estimate Air Tampas, for these delines. Do not round warmediate calculations. Round your answers to two decimal places 1. Air Tampa's r. for $2 million debt: 2. Air Tampa's r. for 54 million debt: 46 6 3. Air Tampa's for $6 million debt: 35 d. Calculate Air Tampa's r, at $6 million debt while assuming its federal-plus-state tax rate is now in the increase in the tax rate use to drop to 110-795714 mm) Do not Intermediate calculations, Round your answer to two decimal places Compare this with your corresponding answer to partc. Higher tax rate le the financial risk premium at a given market value debt/equity ratio