Question
Morrison Medical Inc., an all-equity firm, has earnings before interest and taxes of $950,000, an un-levered beta of .80 and a tax rate = 35%.
Morrison Medical Inc., an all-equity firm, has earnings before interest and taxes of $950,000, an un-levered beta of .80 and a tax rate = 35%. In the market, you observe that Government T-bills are being sold to yield 2% and the S&P/TSX Composite Index is expected to yield 9%. Assume a world with taxes and a cost for the risk of default. All general M&M assumptions apply. You have also been provided the following information:
Value of Debt | Cost of Debt (Rd) | Beta | PV of Financial Distress Costs |
$0 | - | 0.80 | 0 |
$5,000,000 | 5.5% | ? | $800,000 |
$7,000,000 | 7.0% | 2 | ? |
- What is the market value of the firm? (2 marks)
- What is the market value of the firm and the market value of the equity if they issue $5,000,000 in debt with a coupon rate of 4.5% 5.5% and use the proceeds to repurchase shares? (4 marks)
- What is the new cost of equity? (2 marks)
- According to CAPM, what is the new beta? (1 mark)
- Why is the beta calculated in problem 3(d) different than the betas you calculated in problems 1(f) and 2 (d)? (1 mark)
- What is the market value of the firm if the firm issues $7,000,000 in debt? (5 marks)
- What would be the PV of financial distress costs if the firm issues $7,000,000 in debt? (2 marks)
- What is the optimal level of debt $0, $5,000,000 or $7,000,000? Explain. (2 marks)
Please do a,b,c,d
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