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QUESTION 2: Oasis Limited an all equity firm has 1,000,000 shares outstanding. Investors currently require 12.5% return on Oasis common stock. The company pays out
QUESTION 2: Oasis Limited an all equity firm has 1,000,000 shares outstanding. Investors currently require 12.5% return on Oasis common stock. The company pays out all earnings as dividends. The company expects to have EBIT of $5,000,000 per year forever. Assume no personal or corporate taxes. a. What is the value of the firm? Oasis would like to replace some of the equity with $25,000,000 of debt at an interest rate of 6%. 1. What will the new value of the firm be? 2. What will the new value of the debt be? 3. What will the new value of equity be? 4. What will the new required rate of return on equity be? 5. What will the new weighted average cost of capital be? b. Suppose the corporate tax rate is 40%. 1. Using M&M determine the value of the firm, value of the debt, and the value of the equity? 2. Does the presence of the taxes increase or decrease the value of the firm? Why? c. Suppose personal tax rate on debt income is 30% while on the equity income is 20%. 1. What happens to the value of the firm in an MM world with personal taxes? 2. What will happen to the value of the firm as the personal tax rate on debt income increases
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