Wheels for Rent, Inc. is a small company in Panama City, Florida founded 15 years ago by its current CEO, Jim Ferraro. The company buys all-terrain vehicles and rents them to tourists who want to explore the surrounding shoreline. The company has been profitable in each of the past ten years, and shareholders are satisfied with the company's management.

Prior to founding Wheels for Rent, Jim was the founder and CEO of another company which, due to its extreme use of debt, went bankrupt. The bankruptcy made Jim extremely averse to debt financing. As a result, Wheels for Rent is financed entirely with equity. Currently, there are three million shares of common stock outstanding. The firm's current annual earnings before interest and taxes of $9,562,500 are expected to remain at the same level in perpetuity if the firm does not adopt any new projects. In addition, the firm's net working capital is equal to zero, meaning the (market) values of its current assets and current liabilities are equal to each other.

Jim is evaluating a plan to immediately expand operations in Pensacola, Florida. This will require the purchase of new assets (a new building to house the office and a garage for car repairs and maintenance, as well as new all-terrain vehicles) for an estimated cost of $6 million. The expansion is expected to increase the company's annual earnings before interest and taxes by $0.9 million in perpetuity, starting one year from now.

The company's current cost of capital is 7.5 percent, while its corporate tax rate (state and federal) is 20 percent. The firm's investment bank has indicated to Jim that Wheels for Rent could issue perpetual bonds at par value with a coupon rate of 5 percent. The bankers feel that the firm's continuous profitability over the past decade warrants the use of some debt and believe the company would be more valuable if it included debt in its capital structure. As a result, the firm's investment bank has encouraged Jim to consider using debt to finance a part, or even the

total, of the $6 million cost of the expansion.

Jim discussed the investment bank's recommendation with Pauline Lagrange, the company's CFO, who also favors the use of some debt financing by Wheels for Rent. Pauline explained to Jim that although relying too much on debt may lead to a disaster (something that, unfortunately, Jim is well aware of), sensible use of debt may also generate considerable tax shields due to the tax deductibility of the interest paid on the debt. Specifically, Pauline explained to Jim that for each dollar of perpetual debt Wheels for Rent issues today, its current market value will increase by the 20 cents of tax savings it would be able to amass. Jim asked Pauline to provide a report demonstrating the impact debt financing would have on the proposed expansion and the firm's value as a whole. Furthermore, he indicated that the handful of financial analysts following the firm's stock have always been very sensitive to changes in the profitability of the firm's assets, as well as to changes in its earnings per share. Jim said that once he reads the report he will be in a better position to decide how to finance the expansion.

You are Pauline's assistant. To prepare her report, Pauline has asked you to do the following:

1. Using the available information, prepare the firm's current (without the new project) market value balance sheet