TheSam Inc. is all-equity-financed and has EBIT of $250,000. The EBIT is expected to stay at this level indefinitely. The cost of equity is 10% and corporate tax rate is 40%.

a) What is the market value of the firm?

b) Now assume the firm issues $400,000 of debt paying interest of 6% per year and uses the proceeds to retire equity. The debt is expected to be permanent. What will happen to the total value of the firm (debt plus equity)?

c) What happens to the expected return on assets after restructuring the capital struture? [3 marks] d) Recompute your answer to part (b) under the following assumptions: the debt issue raises

the possibility of bankruptcy and expected PV of bankruptcy costs is $50,000.