Short-site.Com earned after-tax cash flows of $10,000,000 last year, and expects the cash flows to continue to infinity. The company has no debt, and its cost of equity is 12%. The corporate tax rate is 40%. Suppose the firm decides to change its capital structure by borrowing at 8% interest. The new debt-to-equity ratio will be 1. Assume that we live in an MM world with taxes, and that the new level of debt will not increase the probability of default significantly.
a) What is the cost of equity after the restructuring?
b) What is WACC after the restructuring?
c) What is the value of the firm before and after the restructuring? Are they the same or different, and why?
d) What other factors that are not considered under the current MM assumption would you recommend that the firm consider before they do the restructuring?

  • CreatedAugust 26, 2013
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