Problem #$5(19$ marks$)$

Pari Inc., an all$-$equity firm, has earnings before interest and taxes of $$950,000,$ an un$-$levered

beta of $\mathrm{.}80$ and a tax rate $=35\%.$ In the market, you observe that Government T$-$bills are being

sold to yield $2\%$ and the S&P$/$TSX Composite Index is expected to yield $9\%.$ Assume M&M case

III, with taxes and a cost for the risk of default. All general M&M assumptions apply. You have

also been provided the following information:

a$)$ What is the market value of the firm? $(2$ marks$)$

b$)$ What is the market value of the firm and the market value of the equity if they issue

$$5,000,000$ in debt with a coupon rate of $5\mathrm{.}5\%$ and use the proceeds to repurchase

shares? $(4$ marks$)$

c$)$ What is the new cost of equity? $(2$ marks$)$

d$)$ According to CAPM, what is the new beta? $(1$ mark$)$

e$)$ Why is the beta calculated in problem $5($d$)$ different than the betas you calculated in

problems $3($f$)$ and $4($d$)?(1$ mark$)$

f$)$ What is the market value of the firm if the firm issues $$7,000,000$ in debt? $(5$ marks$)$

g$)$ What would be the PV of financial distress costs if the firm issues $$7,000,000$ in debt? $(2$

marks$)$

h$)$ What is the optimal level of debt $$0,$$$5,000,000$ or $$7,000,000?$ Explain. $(2$ marks$)$