McRonald’s, which is currently valued at $10,000,000, is looking at changing its capital structure from an all-equity firm to a leveraged firm with 50% debt and 50% equity. Since McRonald’s is a not-for-profit company it pays no taxes.
(a) If the required rate on the assets of McRonald’s is 16% (RA), what is the current required cost of equity and what is the new required cost of equity if the cost of debt is 11%?
(b) If McRonald’s loses its tax-exempt status and will be taxed at 35%, how will its value change under the new leveraged capital structure?