Mrs. Fields runs a chain of BBQ joints called Fields BBQ House (FBH). Currently FBH uses only equity capital....

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Mrs. Fields runs a chain of BBQ joints called Fields BBQ House (FBH). Currently FBH uses only equity capital. Mrs. Fields was approached by representatives from Bankers Corp. who have pointed out to her that FBH's cost of unlevered equity capital is 11% and the cost of debt capital is only 4%. The reps said FBH (which produces after-tax operating cash flows of $4.5 million per year) would benefit from using some debt since debt is the cheaper source of financing. They recommend that FBH issues $10 million worth of bonds and uses the entire proceeds to repurchase $10 million worth of its own stocks. Assume that both the firm's cash flows and the debt are perpetual, and FBH's corporate tax rate is 30%. a) What is the current value of the firm without debt? b) If Mrs. Fields follows Bankers Corp.'s plan, what will be the cost of equity capital and the total value of the firm? c) What would be the value of the firm under the Bankers Corp.'s proposal if interest expenses were not tax deductible? What would be the cost of equity capital in that case (i.e., what would be the cost of equity if Mrs. Fields followed Banker Corp.'s advice even though interest expenses were not tax deductible)?

Answer rating: 100% (QA)

a The current value of the firm without debt can be calculated using the unlevered cost of equity ca View the full answer