Consider the following book value and market value balance sheets. There is no growth, and the debt is expected to be permanent at $40.00. The tax rate is 35%. Assume the MM theory holds except for taxes.
Book Value: Networking capital is $20, Long-term Asset is $80, Debt is $40, Equity is $80
Market Value: Networking capital is $20, Long-term Asset is $140, Debt is $40, Equity is $120
(a) What is the value created by the firm?
(b) What is the value of the tax shield?
(c) Suppose Congress passes a law that eliminates the deductibility of interest after 5 years. What will the new value of the firm be as a result? Assume an 8% interest rate.