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The board of directors of ABC Inc. is examining its capital structure. The company has $ 4 8 , 0 0 0 , 0 0

The board of directors of ABC Inc. is examining its capital structure. The company has
$48,000,000 in total assets, EBIT of $8,000,000, and is in the 40% tax bracket. Currently the firm is using no debt. The value of its common shares is $25/share and the expected return on its stock is 10%.
a) Assume M&M leverage theory with corporate tax (their 1963 paper) holds. Create a table that shows the total dollar value of debt, the total dollar value of equity, and total value of the firm if the firm decides to finance the following percentage of the ($48,000,000) assets by debt: 0%,10%,20%,30%,40%,50%,60%.
b) What will the market value of the share price be at the announcement of a change in capital structure for each of the above levels of debt?
c) How many shares will be left outstanding for each level of debt assuming all debt is used to repurchase shares?
d) ABC can issue debt at an interest rate of 7.5%. What would the net income and earnings per share be for each level of debt?
e) Calculate the required return on equity and the weighted average cost of capital for each level of debt.
f) Verify that the total value of the firm using the Rwacc approach gives the same values as in part (a).
g) According to the above calculations, which of the options is the optimal level of debt to use? Is this necessarily the recommendation you would give to the Board of Directors? Why or why not?

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