Question 1

Swan Specialty Cycles is currently financed with 50 percent debt and 50 percent equity. The firm pays $125 each year to its debt investors (at a 10 percent cost of debt), and the debt has no maturity date.

Required:

What will be the value of the equity if the firm repurchases all of its debt and raises the funds by issuing equity?

Assume that all ofthe assumptions in Case 1 Modigliani and Millers Proposition hold.

Question 2

Valentins Acting School produces annual cash flows of $5,000 and is expected to continue doing so in the infinite future. The cost of equity capital for Valentins is 16percent, and the firm is financed completely with equity. The firm would like to repurchase as much equity as possible but will not pay more than $500 in interest expense to service the debt on the borrowing to finance the repurchase. Valentins can borrow at a10 percent rate (assume that the debt will also be outstanding into the infinite future).

Required

Using Modigliani and Millers Proposition 1 and all of its assumptions, what will be the value of each claim on the firms assets after the stock repurchase?

Question 3

The Boring Corporation is currently valued at $900 million, but management wants to completely pay off its perpetual debt of $300 million. Boring is subject to a 30 percent marginal tax rate.

Required

If Boring pays off its debt, what will be the total value of its equity?