The firm has $20,000$ shares of common stock outstanding. The unlevered cost of capital is $10\%.$

The company distributes all of its earnings to equity holders as dividends at the end of each

year. It estimates that its annual earnings before interest and taxes $($EBIT$)$ will be as follows:

The firm expects the earnings to be unchanged in perpetuity.

a$.$ Assume that there is no corporate tax or other market imperfections. What is the expected

EBIT of the firm per year? $(2$ marks$)$ What is the value of the unlevered firm? $(2$ marks$)$

b$.$ Suppose the firm issues $$10,000$ of perpetual debt and use the proceeds to repurchase

common stock. The bonds will sell at par with a $5\%$ annual coupon rate. After the sale of

the bonds, it will remain the new capital structure forever. The firm is subject to a corporate

tax rate of $20\%.$

Based on the Modigliani and Miller's $($MM$)$ theory,

i$)$ what is the value of the levered firm?

ii$)$ what is the value of the levered firm's equity?

iii$)$ what is the cost of the levered firm's equity?

c$.$ How do the existences of financial distress and corporate taxes affect the firm value

Modigliani and Miller's $($MM$)$ theory in a world with corporate taxes?

$(4$ marks$)$The firm has $20,000$ shares ofcommon stock outstanding. The unlevered cost of capital is $10\%$The company distributes all of its earnings to equity holders as dividends at the end of eachyear. It estimates that its annual earnings before interest and taxes $($EBIT$)$ is $3100.$

The firm expects the earnings to be unchanged in perpetuity.

a$.$ Assume that there is no corporate tax or other market imperfections. What is the value of the unlevered firm? $(2$ marks$)$

Suppose the firm issues $$10,000$ of perpetual debt and use the proceeds to repurchase

b$.$common stock, The bonds will sell at par with a $5\%$ annual coupon rate. After the sale of the bonds, it will remain the new capital structure forever, The firm is subject to a corporate tax rate of $20\%.$

Based on the Modigliani and Miller's $($MM$)$ theory,

i$)$what is the value of the levered firm?

ii$)$what is the value of the levered firm's equity?

iii$)$iii$)$ what is the cost of the levered firm's equity?

c$.$ How do the existences of financial distress and corporate taxes affect the firm value Modigliani and Miller's $($MM$)$ theory in a world with corporate taxes?

d$.$ Suppose that this debt issuance raises the probability of bankruptcy. The firm has a $15$percent chance of going bankrupt after $3$ years. If it does go bankrupt, it will incur bankruptcy costs of $$15,000.$ The discount rate is $10$ percent, If the firm considers the bankruptcy costs, should it issue the debt? Support your analysis with calculations.