Ice Cream Sandwich Co. expects EBIT of $300,000 every year forever. Ice Cream Sandwich Co. currently has no debt and its cost of equity is 20%. The firm can borrow at 5%. The corporate tax rate is 33%. The value of the firm is 1005000.

Questions:
a. what will be the value of the firm if Ice Cream Sandwich Co. borrows $280,000 of permanent debt and uses the proceeds to buy back stock?
b. how can Ice Cream Sandwich Co. maximize the value of the firm? What will be the maximum value if there are no costs to financial distress?
c. Suppose that with $280,000 of debt, there is a 13% probability of financial distress, in which case the firm will have a present value of $220,000. What is the value of the firm in this case? 

Answer rating: 100% (QA)

Perpetual EBIT 300000 Since the company does not have any debt therefore the company is an unlevered firm and also cost of equity Unlevered cost of eq... View the full answer