a. The ABC Company has a simple capital structure. Management wants to substitute $100 million of 0.12 debt for common stock. What effect will the change have on the value of the firm to a zero-tax investor who owns all the stock? The corporate tax rate is 0.35.

b. The XYZ Company is thinking of acquiring a firm that is earning before tax $100,000 a year. The borrowing rate of XYZ is 0.10, and its tax rate is 0.35. Thus, its after-tax borrowing rate is 0.054. The investment in the firm will be financed with sufficient debt to cause the amount of income taxes paid to be zero on this investment.

What is the maximum amount that XYZ could afford to pay for the firm?