Overnight Publishing Company (OPC) has $4.2 million in excess cash. The firm plans to use this cash either to retire all of its outstanding debt or to repurchase equity. The firm's debt is held by one institution that is willing to sell it back to OPC for $4.2 million. The institution will not charge OPC any transaction costs. Once OPC becomes an all-equity firm, it will remain unlevered forever. If OPC does not retire the debt, the company will use the $4.2 million in cash to buy back some of its stock on the open market. Repurchasing stock also has no transaction costs. The company will generate $1,470,000 of annual earnings before interest and taxes in perpetuity regardless of its capital structure. The firm immediately pays out all earnings as dividends at the end of each year. OPC is subject to a corporate tax rate of 22 percent and the required rate of return on the firm's unlevered equity is 16 percent. The personal tax rate on interest income is 34 percent and there are no taxes on equity distribution. Assume there are no bankruptcy costs. a. What is the value of OPC if it chooses to retire all of its debt and become an unlevered firm? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to the nearest whole number, e.g.. 1,234,567.) b. What is the value of OPC if it decides to repurchase stock instead of retiring its debt? (Hint Use the equation for the value of a levered firm with personal tax on interest income from Problem 9 in the textbook) (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to the nearest whole number, e.g., 1,234,567.) c. What is the value of OPC if the expected bankruptcy costs have a present value of $900,000? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to the nearest whole number, e.g. 1,234,567.) a. Company value b. Company value c. Unlevered value Levered value (Questions 9-10) 9. Personal Taxes, Bankruptcy Costs, and Firm Value When personal taxes on interest income and bankruptcy costs are considered, the general expression for the value of a levered firm in a world in which the tax rate on equity distributions equals zero is: Vi = Vy + (1 - [(1 - Tc (1 - Tp)]) XB-C(B) where: V - The value of a levered firm. Vu - The value of an unlevered firm. B - The value of the firm's debt. Tc - The tax rate on corporate income. T8 - The personal tax rate on interest income. CIB)- The present value of the costs of financial distress. a. In their no-tax model, what do Modigliani and Miller assume about Tc. Tg. and C(B)? What do these assumptions imply about a firm's optimal debt-equity ratio? b. In their model with corporate taxes, what do Modigliani and Miller assume about Tc. T's and C(B)? What do these assumptions imply about a firm's optimal debt-equity ratio? c. Consider an all-equity firm that is certain to be able to use interest deductions to reduce its corporate tax bill. If the corporate tax rate is 25 percent, the personal tax rate on interest income is 20 percent, and there are no costs of financial distress, by Page 549 how much will the value of the firm change if it issues $1 million in debt and uses the proceeds to repurchase equity? d. Consider another all-equity firm that does not pay taxes due to large tax loss carryforwards from previous years. The personal tax rate on interest income is 20 percent and there are no costs of financial distress. What would be the change in the value of this firm from adding S1 of perpetual debt rather than $1 of equity? 10. Personal Taxes, Bankruptcy Costs, and Firm Value Overnight Publishing Company (OPC) has $2.5 million in excess cash. The firm plans to use this cash either to retire all of its outstanding debt or to repurchase equity. The firm's debt is held by one Institution that is willing to sell it back to OPC for $2.5 million. The institution will not charge OPC any transaction costs. Once OPC becomes an all equity firm, it will remain unlevered forever. If OPC does not retire the debt, the company will use the $2.5 million in cash to buy back some of its stock on the open market. Repurchasing stock also has no transaction costs. The company will generate 51.3 million of annual earnings before interest and taxes in perpetuity regardless of its capital structure. The firm immediately pays out all earnings as dividends at the end of each year. OPC is subject to a corporate tax rate of 21 percent and the required rate of return on them's unlevered equity is 20 percent. The personal tax rate on interest income is 25 percent and there are no taxes on equity distributions. Assume there are no bankruptcy costs Overnight Publishing Company (OPC) has $4.2 million in excess cash. The firm plans to use this cash either to retire all of its outstanding debt or to repurchase equity. The firm's debt is held by one institution that is willing to sell it back to OPC for $4.2 million. The institution will not charge OPC any transaction costs. Once OPC becomes an all-equity firm, it will remain unlevered forever. If OPC does not retire the debt, the company will use the $4.2 million in cash to buy back some of its stock on the open market. Repurchasing stock also has no transaction costs. The company will generate $1,470,000 of annual earnings before interest and taxes in perpetuity regardless of its capital structure. The firm immediately pays out all earnings as dividends at the end of each year. OPC is subject to a corporate tax rate of 22 percent and the required rate of return on the firm's unlevered equity is 16 percent. The personal tax rate on interest income is 34 percent and there are no taxes on equity distribution. Assume there are no bankruptcy costs. a. What is the value of OPC if it chooses to retire all of its debt and become an unlevered firm? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to the nearest whole number, e.g.. 1,234,567.) b. What is the value of OPC if it decides to repurchase stock instead of retiring its debt? (Hint Use the equation for the value of a levered firm with personal tax on interest income from Problem 9 in the textbook) (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to the nearest whole number, e.g., 1,234,567.) c. What is the value of OPC if the expected bankruptcy costs have a present value of $900,000? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to the nearest whole number, e.g. 1,234,567.) a. Company value b. Company value c. Unlevered value Levered value (Questions 9-10) 9. Personal Taxes, Bankruptcy Costs, and Firm Value When personal taxes on interest income and bankruptcy costs are considered, the general expression for the value of a levered firm in a world in which the tax rate on equity distributions equals zero is: Vi = Vy + (1 - [(1 - Tc (1 - Tp)]) XB-C(B) where: V - The value of a levered firm. Vu - The value of an unlevered firm. B - The value of the firm's debt. Tc - The tax rate on corporate income. T8 - The personal tax rate on interest income. CIB)- The present value of the costs of financial distress. a. In their no-tax model, what do Modigliani and Miller assume about Tc. Tg. and C(B)? What do these assumptions imply about a firm's optimal debt-equity ratio? b. In their model with corporate taxes, what do Modigliani and Miller assume about Tc. T's and C(B)? What do these assumptions imply about a firm's optimal debt-equity ratio? c. Consider an all-equity firm that is certain to be able to use interest deductions to reduce its corporate tax bill. If the corporate tax rate is 25 percent, the personal tax rate on interest income is 20 percent, and there are no costs of financial distress, by Page 549 how much will the value of the firm change if it issues $1 million in debt and uses the proceeds to repurchase equity? d. Consider another all-equity firm that does not pay taxes due to large tax loss carryforwards from previous years. The personal tax rate on interest income is 20 percent and there are no costs of financial distress. What would be the change in the value of this firm from adding S1 of perpetual debt rather than $1 of equity? 10. Personal Taxes, Bankruptcy Costs, and Firm Value Overnight Publishing Company (OPC) has $2.5 million in excess cash. The firm plans to use this cash either to retire all of its outstanding debt or to repurchase equity. The firm's debt is held by one Institution that is willing to sell it back to OPC for $2.5 million. The institution will not charge OPC any transaction costs. Once OPC becomes an all equity firm, it will remain unlevered forever. If OPC does not retire the debt, the company will use the $2.5 million in cash to buy back some of its stock on the open market. Repurchasing stock also has no transaction costs. The company will generate 51.3 million of annual earnings before interest and taxes in perpetuity regardless of its capital structure. The firm immediately pays out all earnings as dividends at the end of each year. OPC is subject to a corporate tax rate of 21 percent and the required rate of return on them's unlevered equity is 20 percent. The personal tax rate on interest income is 25 percent and there are no taxes on equity distributions. Assume there are no bankruptcy costs