Problem:

Assume perfect capital markets except for taxes, which is levied on the firm at a (marginal and average) tax rate of 20%. The firm's revenue and expenses (both cash and non-cash) are expected to continue at the same level forever, and they are as follows:

• Cash Revenue $70 million
• Cash Expenses $30 million
• Depreciation (non-cash expense) $10 million

Assume the firm's equity Beta is 0.9, the risk premium on the market (Expected Market Return minus the risk free rate) is 5%, and the return on risk free government bonds is 3%.

Requirement:

Question 1: What is this firm's after tax cash flow if there is no debt in the capital structure?

Question 2: What is the value of this firm if there is no debt in the capital structure?

Question 3: Now suppose the firm repurchases half of the equity and finances that repurchase with a new perpetual debt issue costing 3%. What is the new value of the firm?

Question 4: What is the (after tax) weighted average cost of capital for this firm after the above capital structure change?

Question 5: What happens to stockholders' wealth as a result of this capital structure change (the stockholders that held the stock at the time of the capital structure change.)

Note:  Please answer in proper manner and show all computations