5. Problem 3 (32 marks)

   Your best friend is in a senior position of the finance department of Teenie Tiny and you are having lunch together after a round at the golf course. The discussion gets around to the fact that Teenie Tiny will lose their tax-exempt status and your friend mentions that all the debt that the company needs will be financed using bonds with a 5 percent coupon. However, you remember that during a lecture at SMU, it was mentioned that as a company issues more and more debt, the risk for the bondholders will increase and bondholders will require coupon interest rates to increase as the amount of debt increases. You have prepared the following table to assist in answering these questions:

   		Value of Debt	RD	Beta
   EBIT	800,000	0	5.0%	1.392500
   Tax Rate	40%	250,000	5.5%	1.483015
   T-bill Rate	3.0%	500,000	6.0%	1.542274
   TSX	11.0%	750,000	6.5%	1.607016
   		1,000,000	7.0%	1.678038
   		1,250,000	9.0%	1.756303
   		1,500,000	11.0%	1.842075
   		1,750,000	13.0%	1.939488
   		2,000,000	15.0%	2.047619

   5. Calculate the present value of distress. (4 marks)

Value of Debt	Value of the Firm World III	Value of the Firm World II	PV of Distress World III World II
0
250,000
500,000
750,000
1,000,000
1,250,000
1,500,000
1,750,000
2,000,000

6. Graph (on 2 separate graphs) the information for proposition I and proposition II. (4 marks)
7. Briefly explain the amount of debt the company should use as a levered company. (2 marks)

To maximize the value of the firm and to minimize the WACC for the firm, the unlevered firm should issue $1,000,000 of debt.

Note:

Look Up the question on chegg to get the first 4 parts.