In year 1, ABC will earn $2000 before interest and taxes. The market expects these earnings to grow at a rate of 3% per year. The firm will make no net investments (that is, capital expenditures will equal depreciation) or changes to net working capital. Assume that the corporate tax rate equals 40%. In year 1, the firm will have $5000 in risk-free debt. It plans to keep a constant ratio of debt to equity every year, so that on average the debt will also grow by 3% per year. Suppose the risk-free rate equals 5%, and the expected return on the market equals 11%. The asset beta for this industry is 1.11.

(a) If ABC was an all-equity (unlevered) firm, what would its market value be? [20 marks]

(b) Assuming the debt is fairly priced, what is the amount of interest ABC will pay next year? If ABC's debt is expected to grow by 3% per year, at what rate, its interest payments are expected to grow? [10 marks]

(c) Even though ABC's debt is riskless (the firm will not default), the future growth of ABC's debt is uncertain, so the extra amount of the future interest payments is risky. Assuming the future interest payments have the same beta as ABC's assets, what is the present value of ABC's interest tax shield? [20 marks]

(d) Using the APV method, what is ABC's total market value, VL ? What is the market value of ABC's equity? [15 marks]

(e) What is ABC's WACC?