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1) The market value of United Frypan Company is given below:

VDO = $40.00 (Value of Debt)
VEO = $120.00 (Value of Equity)

The tax rate is 40% and interest is tax deductible. Company is a perpetual steady state company. Presently the debt is yielding 8%.

a) How much of firm's value is accounted for by debt generated subsidy?

b) How much better off will UF's shareholders be if firm borrows $20 more and utilizes it to repurchase stock? Interest rate will be 10% with this higher debt level.

c) Now assume that Congress passes the law that will phase out deductibility of interest for tax purposes after the period of five years. Determine the new value of firm, all other things remaining equal.

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