Market Value Balance Sheet d) What is Lost Socks? total asset cost of capital? (Hint: a firm?s total asset cost of capital is equal to the firm?s total liability and equity?s cost of capital.) e) What s Lost Socks? physical asset cost of capital? (Hint: if a firm maintains a constant leverage ratio, the firm?s tax shield has the same risk as the firm?s physical assets.) f) What is Found Socks? physical asset cost of capital? What is Found Socks? total asset cost of capital? (Hint: the free cash flows of Lost Socks and Found Socks are identical.) g) What is Found Socks? equity cost of capital? h) What is Found Socks? WACC with taxes? i) Compare the two companies? WACC with taxes. Which company will have the higher total asset value? (Hint: the levered value of a firm, the total asset value of a firm including the value of the tax shield, is the present value of the firm?s free cash flows discounted at its WACC with taxes.) Lost Socks and Found Socks are both coin laundry companies. The free cash flows of these two companies are identical. However, the capital structure of these two companies is different; Lost Socks has a constant debt-to-equity ratio of 1 while Found Socks has a constant debt-to-equity ratio of 1/4. Both companies? debt is risk-free. Lost Socks? equity cost of capital is 20%. The risk-free rate is 5%. The corporate tax rate is 40%. a) Calculate Lost Socks? leverage ratio. (Hint: leverage ratio = D/D+E) b) Calculate Lost Socks? WACC with taxes. c) Calculate Lost Socks? WACC without taxes. Because interest payments are tax deductible, debt generates interest tax shields. A firm?s market value is its physical asset value plus the present value of its tax shield. Market Value Balance Sheet