- We consider the example in Lecture Notes 8. The project requires initial investment $800. The risk free rate is 5% and the unlevered cost of capital of the project is 15%. In the following graph, EBIT is the before-tax income of the firm. The corporate tax rate is 20%, and the taxable income of the firm is calculated as (EBIT-Initial Investment-Interest Payment (if any)). The firm has a debt with $900 principal and 5% coupon rate. F.D.C is the financial distress cost, which is as large as $45 if the firm cannot pay the debt holder in full. EBIT $1400 Tax $? F.D.C $? Debt $? Equity $? 0.5 0.5_ $900 $? $? $? $? (a) Calculate the risk-neutral probabilities. (b) Calculate taxes, F.D.C., debt payments and equity flows in different states (fill in the numbers using the graph). (c) What would be the optimal amount of debt in order to maximize levered firm value? [Hint: think about PV(tax shield) v.s. PV(F.D.C). You can try some numbers (debt) to get a better sense] - We consider the example in Lecture Notes 8. The project requires initial investment $800. The risk free rate is 5% and the unlevered cost of capital of the project is 15%. In the following graph, EBIT is the before-tax income of the firm. The corporate tax rate is 20%, and the taxable income of the firm is calculated as (EBIT-Initial Investment-Interest Payment (if any)). The firm has a debt with $900 principal and 5% coupon rate. F.D.C is the financial distress cost, which is as large as $45 if the firm cannot pay the debt holder in full. EBIT $1400 Tax $? F.D.C $? Debt $? Equity $? 0.5 0.5_ $900 $? $? $? $? (a) Calculate the risk-neutral probabilities. (b) Calculate taxes, F.D.C., debt payments and equity flows in different states (fill in the numbers using the graph). (c) What would be the optimal amount of debt in order to maximize levered firm value? [Hint: think about PV(tax shield) v.s. PV(F.D.C). You can try some numbers (debt) to get a better sense]