Question 2 (answer all parts of the question)

a. Benflex Inc. is expected to have free cash flow next year of $8 million, and this cash flow is expected to grow at 3% per year thereafter.Benflex has an equity cost of capital of 13%, a debt cost of capital of 7%, and it is in the 35% corporate tax bracket.

i. If Benflex maintains a 0.5 debt to equity ratio, then what is Benflex's pre-tax WACC (weighted average cost of capital)?

ii. If Benflex currently maintains a 0.5 debt to equity ratio, then what is the value of Benflex as an all equity firm?

iii. If Benflex currently maintains a 0.5 debt to equity ratio, then what is Benflex's after-tax WACC?

iv. If Benflex currently maintains a 0.5 debt to equity ratio, then what is the value of Benflex as a levered firm?

TURN OVER

2

v. If Benflex currently maintains a 0.5 debt to equity ratio, then what is the value of Benflex's interest tax shield?[15 + 10 + 20 + 10 + 15 = 70 marks]

b. Critically discuss the set of conditions referred to as the perfect capital market conditions. Why these conditions are commonly used while developing a theory given that these are far from reality? [30 marks]