The firm Summer Has a market capitalization of 800 and debt with a market value of 200.
Question:
The firm Summer Has a market capitalization of 800 and debt with a market value of 200. The equity beta is 1. the debt beta is 0, and the riskiness of the tax
shield equals the riskiness of the assets. The all equity firm New Summer! is in a similar line of business and has expected cash flows after tax of 80 in perpetuity (starting next year. The corporate tax rate is 30% and there are no personal taxes. The risk free rate is 4% and the expected rate of return on the market portfolio is 9%.
You have been asked to look into the implications of adding debt to the capital structure of New Summer: You decide to investigate two debt policies.
Policy 1 involves having a constant debt to value ratio of 50%. The debt will be risk free.
Policy 2 involves having a fixed amount of debt of 500 in perpetuity, which can be issued at par with a coupon of 4%.
Required: Calculate the market values immediately after the change in capital structure.
calculate the following questions
a) under policy 1 what is the firm value, equity value, debt value, what about under policy 2
b)what is the reason behind the difference
Expert Answer:
ANSWER a Under Policy 1 the firm value can be calculated as follows First calculate the unlevered beta for New Summer using the equity beta and the de... View the full answer
