Colt Systems will have EBIT this coming year of

$ 29

million. It will also spend

$ 14

million on total capital expenditures and increases in net working capital, and have

$ 8

million in depreciation expenses. Colt is currently an all-equity firm with a corporate tax rate of

38 %

and a cost of capital of

10 %

.

a. If Colt's free cash flows are expected to grow by

6.7 %

per year, what is the market value of its equity today?

b. If the interest rate on its debt is

8 %

,

how much can Colt borrow now and still have non-negative net income this coming year?

c. Is there a tax incentive today for Colt to choose a debt-to-value ratio that exceeds

110 %

?

Explain.