Alias Industries is currently an all-equity firm. In the coming year the firm is forecasting annual EBIT level $580,000. The firm expects no growth in the EBITs as it will pay all the earnings in cash dividends to its shareholders. As a result, the EBIT level of $580,000 will remain constant forever. The asset beta of the firm has an estimated value of 1.25. The expected return on a Government of Canada treasury bill is 2.2%, and the return on the TSX composite index is 7.6%. The firm has 260,000 shares of common stock outstanding.

M&M Case III: Assume tax rate is 35% and default risk is present.

As default risk is present, the borrowing rate for the firm varies with its financial leverage as indicated in the following table. R_D is the before tax cost of debt.

Value of Debt	RD		Beta of Equity
0	2.2%		1.25
600,000	2.5%		1.350
1,200,000	2.5%		1.462
1,800,000	3.7%		1.630
2,400,000	5.6%		1.820
3,000,000	8.3%		2.060
3,600,000	10.4%		2.861

g) What is the WACC of this all-equity financed firm? What is the value of the firm? What is the market price per share of the firm? (3 marks)

h) What would be the firms value and overall cost of capital, if the firm uses $2,400,000 (market value) debt in generating its EBITs of $580,000? (4 marks)

i) Complete the following table. (1mark)

Value of		Value of	Value of		RD		RE		WACC
Firm		Debt	Equity
??		0	??		2.2%		??		??
4,469,863		600,000	3,869,863		2.5%		9.490%		8.434%
4,741,427		1,200,000	3,541,427		2.5%		10.095%		7.951%
4,833,176		1,800,000	3,033,176		3.7%		11.002%		7.800%
??		2,400,000	??		5.6%		??		??
4,614,755		3,000,000	1,614,755		8.3%		13.324%		8.169%
4,357,193		3,600,000	757,193		10.4%		17.649%		8.652%

j) Draw a graph of financial leverage against firm value. Show leverage (D/E) on the x-axis and firm value on the y-axis. You can draw this graph by hand, Excel not required. (2 marks)

11. In M&M Case III, what level of debt is optimal? (1 mar