1. Referring to Table 13.2, calculate the market value of firm L (without a corporate income tax) if the equity amount in its capital structure decreases to $5,000 and the debt amount increases to $5,000. At this capital structure, the cost of equity is 15 percent.
2. a. Referring to Table 13.3, calculate the market value of firm L (with a corporate income tax) if the equity amount in its capital structure decreases to $3,000 and the debt amount increases to $3,000.
b. For firm L (with equity ¼ $3,000 and debt ¼ $3,000), calculate (i) the income available to the stockholders and (ii) the cost of equity.
3. Two firms, No Leverage, Inc., and High Leverage, Inc., have equal levels of operating risk and differ only in their capital structure. No Leverage is unlevered and High
Leverage has $500,000 of perpetual debt in its capital structure. Assume that the per- petual annual income of both firms available for stockholders is paid out as dividends. Hence, the growth rate for both firms is zero. The income tax rate for both firms is 40 percent. Assume that there are no financial distress costs or agency costs. You are given the following data:
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No Leverage, Inc.
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High Leverage, Inc.
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Equity in capital structure
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$1,000,000
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$500,000
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Cost of equity, ke
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10%
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13%
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Debt in capital structure
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-
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$500,000
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Pretax cost of debt, kd
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-
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7%
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Net operating income (EBIT)
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$ 100,000
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$100,000
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Determine the
a. Market value of No Leverage, Inc.
b. Market value of High Leverage, Inc.
c. Present value of the tax shield to High Leverage, Inc.