Here are book and market value balance sheets of the United Frypan Company.
Book value balance sheet
Net working capital 25 Debt 60
Long term assets 75 Equity 40
100 100
Market value balance sheet
Net working capital 25 debt 60
Long term assets 180 equity 145
205 205
Assume that MM's theory holds except for taxes. There is no growth, and the $60 of debt is expected to be permanent. Assume a 33% corporate tax rate.
a. How much of the firm's market value is accounted for by the debt generated tax shield? (PV Tax Shield)
b. What is United Frypan's after tax WACC if r debt= 6.7% and r equity = 16.3% (WACC %)
c. Now suppose that congress passes a law that eliminates the deductibility of interest for tax purposes. What will be the new value of the firm, other things equal? Assume a borrowing rate of 6.7%