Smoke and Mirrors has EBIT of 25000 and is all equity financed. EBIT is expected to stay

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Smoke and Mirrors has EBIT of 25000 and is all equity financed. EBIT is expected to stay at this level indefinitely. the firm pays corporate taxes equal to 35% of taxable income. The discount rate for the firm's project is 10 percent.

(a) What is the market value?

(b) Now assume the firm issues 50000 of debt paying interest of 6% per year and uses the proceeds to retire equity. The debt is expected to be permanent. What will happen to the total value of the firm?

(c) Re-compute your answer to part (b), under the following assumptions, the debt issue raises the possibility of bankruptcy; the firm has a 30% chance of going bankrupt after 3 years; if it does go bankrupt, it will incur bankruptcy costs of 200,000. The discount rate is 10% should the firm issue the debt?

Discount Rate
Depending upon the context, the discount rate has two different definitions and usages. First, the discount rate refers to the interest rate charged to the commercial banks and other financial institutions for the loans they take from the Federal...
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Related Book For  answer-question

Fundamentals of Corporate Finance

ISBN: 978-1260566093

10th edition

Authors: Richard Brealey, Stewart Myers, Alan Marcus

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