NET WORKING CAPITAL 550 DEBT 800
LONG TERM ASSETS 2150 EQUITY 1900
VALUE OF THE FIRM 2700 2700
The debt is yielding 7 percent, and cost of equity is 14 percent. Tax rate is 35 percent. Investors expect this level of debt to be permanent.
a. Determine Establishment's WACC?
b. Write about a market-value balance sheet supposing Establishment has no debt.
Costs of Financial Distress. For which of the given firms would you expect costs of financial distress to be highest? Describe briefly.
c. A computer software company which depends on skilled programmers to manufacture new products.
d. A shipping company which operates the fleet of modern oil tankers.
Trade-Off Theory. Smoke and Mirrors presently has EBIT of $25,000 and is all-equity-financed. EBIT is expected to stay at this level indefinitely. Firm pays corporate taxes equal to 35 percent of taxable income. Discount rate for firm's projects is 10 percent.
e. Determine the market value of the firm?
f. Now suppose firm issues $50,000 of debt paying interest of 6 percent per year, using proceeds to retire equity. Debt is expected to be permanent. What will occur to total value of firm (debt plus equity)?
g. Recompute your answer to (b) under following assumptions: Debt issue raises probability of bankruptcy. Firm has 30 percent chance of going bankrupt after 3 years. If it does go bankrupt, it will incur bankruptcy costs of $200,000. Discount rate is 10 percent. Must firm issue debt?