Treasure Island Inc is currently 100% equity financed with 0% debt. Treasure Island is currently based in a tax haven with 0% corporate income tax. The firm is considering taking on debt capped at 0.5x of equity. It is also considering moving its headquarters to Ireland which currently has a tax rate of 12.5% but you are concerned that recent tax proposals by the OECD will result in Treasure Island paying 15.0% corporate tax. Any funds raised by debt issuance will be used to repurchase existing shares at the current share price based on the value without taxes or debt. The firm currently has 10,000 shares outstanding.

Using your knowledge of Modigliani and Miller I & II calculate the following under four scenarios:

1) Firm Value Unlevered (Vu),

2) Firm Value Levered (Vl),

3) Cost of Equity (Re) and

4) Weighted Average Cost of Capital (WACC).

Treasure Island expects: To have operating profit/earnings before interest and tax (EBIT) = 500,000 forever. To pay 15 percent annual interest on any debt issuance. Treasure Island is a risky firm with a beta of 2.0. The risk-free rate of interest is 4 percent, and the expected return on the market portfolio equals 12 percent. (30 points)

Required:

i. Calculate the four M&M measures above with no debt and no taxes?

ii. Calculate the four M&M measures above with a 0.5 D/E and no taxes?

iii. Calculate the four M&M measures above with a 0.5 D/E and taxes of 12.5%?

iv. Calculate the four M&M measures above with a 0.5 D/E and taxes of 15.0%?

v. Does the move to Ireland increase or decrease Treasure Islands firm value? Assuming Treasure Island relocates to Ireland should it change its debtequity ratio if the goal is to maximize the value of the firm? Explain.

vi. Treasure Island is concerned about its ability to maintain its going concern status with its auditors and has just been made aware of the Static Theory of Capital Structure, how would this affect your response to part v.