You own all of the equity in a debt-free App development business that generates cash flows of

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You own all of the equity in a debt-free App development business that generates cash flows of $400,000 each year in perpetuity. The cost of assets, kAssets is 10 percent and the tax rate is 25 percent. What is the value of your all-equity firm? If you decide to replace $1 million of equity by borrowing $1 million at an interest rate of 6 percent, how much would the value of the firm increase? What would the kcs and WACC for your business be before and after the proposed financial restructuring? Use M&M Proposition 2 with taxes, Equation 16.5, to determine the expected return on the equity for input to the WACC calculation. Assume that all cash flows are perpetuities and that the second and third M&M conditions hold.

Expected Return
The expected return is the profit or loss an investor anticipates on an investment that has known or anticipated rates of return (RoR). It is calculated by multiplying potential outcomes by the chances of them occurring and then totaling these...
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Fundamentals of Corporate Finance

ISBN: 978-1119371403

4th edition

Authors: Robert Parrino, David S. Kidwell, Thomas Bates

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