Question on attached file.write down detailed steps.

Part I Capital Structure

Consider an all-equity firm that is contemplating going into debt.

Question 1: Fill in the blank (Table I)

The following table is a brief summary of the company balance sheet under current and proposed capital structure. The Company will use the proceeds from bond issue to repurchase its stock. After the repurchase, what will be the stock price and shares outstanding? Input the numbers in table I.

Table I

Current

Proposed

Assets

5,000,000

5,000,000

Debt

0

2,500,000

Equity

5,000,000

2,500,000

Debt/Equity Ratio

0

1

Interest Rate

N/A

10%

Shares Outstanding

500,000

Share Price

$10

Question 2: Fill in the blank (Table II and Table III)

Based on the current and proposed capital structure, the company is conducting scenario analysis to determine some benchmark performance (EPS, ROE) of the company. Your job is to help managers making the capital structure decision by finishing the following two tables.

Table II Current Capital Structure:

Recession

Expected

Expansion

EBIT

300,000

500,000

700,000

Interest

Net Income

EPS

ROE

Table III Proposed Capital Structure:

Recession

Expected

Expansion

EBIT

300,000

500,000

700,000

Interest

Net Income

EPS

ROE

Question 3: Homemade Leverage

Based on the scenario analysis, the company's conservative management decide to maintain the current capital structure by not using leverage. However, the practice upsets a major prospective investor because he think the company is not acting in the interests of the shareholders. Even so, he is still interested in investing because in a world with no tax and perfect capital market, he can use homemade leverage by borrowing at 10%, the same interest rate offered to the company. Assume he is interested in buying 100,000 shares of the company's stock. How much should he borrow to replicate the ROE outcome under proposed capital structure? And show the expected outcome of using homemade leverage by finishing table IV.

a. How much should he borrow?

b. Fill in the blanks (Table IV)

Recession

Expected

Expansion

EPS under unlevered firm

Net Income for 100,000 shares

Homemade leverage Interests

Net Profit

ROE

Question 4: A World With Tax

Based on M&M theory with no tax, capital structure doesn't matter due to homemade leverage. However, no tax is an assumption too strong. Luckily, this assumption can be easily relaxed which lead to M&M theory with tax. M&M theory with tax suggests: the value of the levered firm is equal to the value of the unlevered firm plus tax shield (V_L = V_U + T_C*B).

Please explain why the value of tax shield = T_C*B?

Hints: Start from the income statement. Use income statement to calculate the increase in annual cash flow because of the interest payment. And finally use perpetuity to valuation the tax shield.