Task 1: Acme Storage has a market capitalization of $100 million and debt outstanding of $40 million. Acme plans to maintain this same debt-equity ratio in the future. The firm pays an interest rate of 7.5% on its debt and has a corporate tax rate of 35%.
A) If Acme's free cash flow is expected to be $7 million next year and is expected to grow at a rate of 3% per year, what s Acme's WACC?
B) What is the value of Acme's interest tax shield?
Task 2: Suppose Tefco Corp. has a value of $100 million if it continues to operate, but has outstanding debt of $120 million that is now due. If the firm declares bankruptcy, bankruptcy cost will equal $20 million, and the remaining $80 million will go to creditors. Instead of declaring bankruptcy, management proposes to exchange the firm's debt for a fraction of its equity in a workout. What is the minimum fraction of the firm's equity that management would need to offer creditors for the workout to be successful?
Task 3: Apple Computer has no debt. As problem 21 in Chapter 15 makes clear, by issuing debt Apple can generate a very large tax shield potentially worth over $10 billion. Given Apple's success, one would be hard pressed to argue that Apple's management are naive and unaware of this huge potential to create value. A more likely explanation is that issuing debt would entail other cost. What might these costs be?