Smoke and Mirrors has EBIT of 25000 and is all equity financed. EBIT is expected to stay at this level indefinitely. the firm pays corporate taxes equal to 35% of taxable income. the discount rate for the firm's project is 10 percent.
a) What is the market value?
b) Now assume the firm issues 50000 of debt paying interest of 6% per year and uses the proceeds to retire equity. the debt is expected to be permanent. what will happen to the total value of the firm?(debt plus equity)
c) Re compute your answer to partb, under the following assumptions, the debt issue raises the possibility of bankruptcy ; the firm has a 30% chance of going bankrupt after 3 years; if it does go bankrupt,it will incur bankruptcy costs of 200000. the discount rate is 10% should the firm issue the debt?