Suppose that your firm is currently all-equity-financed and has an annual pre-tax income of RM 100,000 which is expected to remain constant forever. Your firm applies a 10% discount rate to all its projects and a 30% tax rate on its pre-tax income.

a) Determine your firm's market value.

b) Suppose your firm is considering issuing RM200,000 worth of bonds at a funding cost of 5% per annum. You expect this debt to be a permanent feature in your firm's capital structure. What will your firm's market value be after this bond issuance exercise?

c) Suppose you expect that the issuance of the RM200,000 debt in (b) above would give rise to potential risk of bankruptcy. There is a 50% chance that your firm will incur bankruptcy cost of RM300,000 in four years' time. What will your firm's market value be after considering the information about the debt issuance and the expected bankruptcy cost?

d) Given your answer in (c), should your firm issue the bonds? Why or why not?

Separately, suppose that your firm is considering buying Company Xecon's optical products division. In order to value this division, your Chief Executive Officer (CEO) suggests computing the present value of the division's free cash flows (FCF) rather than dividends or eamings per share. Answer the following:

i) What is meant by free cash flows'?

ii) )Do you agree with your CEO's suggestion? Why or why not?

Answer rating: 100% (QA)

Answers aRM 700000 bRM 760000 cRM 55509596 d The firm should not issue th... View the full answer