Question
An unlevered firm has a book value of equity $100 million and is considering borrowing $40 million at 8% interest rate to buy back stocks.
An unlevered firm has a book value of equity $100 million and is considering borrowing $40 million at 8% interest rate to buy back stocks. Once the company issues the debt, it becomes a levered company. The company is in a 35% tax bracket and has an EBIT of $15 million.
1.) What is the net income of the unlevered company?
2..) Assuming that all net income is distributed as dividend and this amount is expected to remain constant forever, what is market price of equity of the unlevered company Assume cost of equity is 9.75%. Use the perpetuity formula.
3.) What is the net income after debt is issued?
4.) What is the tax savings per year for the levered company?
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