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Consider an all-equity project with the following characteristics: Cash inflows = $18,000 per year in perpetuity Cash outflows (costs) =50% of cash inflows Corporate tax
Consider an all-equity project with the following characteristics:
- Cash inflows = $18,000 per year in perpetuity
- Cash outflows (costs) =50% of cash inflows
- Corporate tax rate = 35%
- Cost of capital of all-equity project = 12%
Now suppose that the management issues debt to finance a share repurchase program. The new cost of capital of the levered project is 10%. (Hint: Solve part a. first).
- Using this information, determine the present value of the tax shield of debt.
- Assuming that the debt is static, perpetual, and risk free, what is the current level of debt in the firm?
Edit: The interest rate of debt should be calculated using the new cost of capital vs the cost of capital for the all equity project I think. No other information is given on the question.
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