BOOK VALUE:
Net working capital $20 Debt $40
Long term assets 80 Equity 60
MARKET VALUE:
Net working capital $20 Debt $40
Long term assets 140 Equity 120
Suppose that MM's theory holds except for taxes. There is no growth and $40 of debt is expected to be permanent. Suppose 35% corporate tax.
a) How much of firm's value is accounted for by debt generated tax shield?
b) Determine UF's after tax WACC if rd=0.8% and re=15%?
c) Now assume that government passes the law which eliminates deductibility of interest for tax purposes after grace period of 5 years. Determine the new value of firm, all things equal? Suppose a 8% borrowing rate.