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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).

  1. Using this information, determine the present value of the tax shield of debt.

  1. 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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