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14-2. Here are book and market value balance sheets of the U

14-2. Here are book and market value balance sheets of the United Frypan Company (UF):

Book Market

Net working capital $ 20 $ 40 Debt Net working capital $ 20 $ 40 Debt
Long- term assets 80 60 Equity Long- term assets 140 120 Equity
$ 100 $ 100 $ 160 $ 160

Assume that MM's theory holds with taxes. There is no growth, and the $ 40 of debt is expected to be permanent. Assume a 40% corporate tax rate.

a. How much of the firm's value is accounted for by the debt-generated tax shield?
b. How much better off will UF's shareholders be if the firm borrows $20 more and uses it to repurchase stock?

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14-2. Here are book and market value balance sheets of the United Frypan Company (UF):

Book Market

Net working capital $ 20 $ 40 Debt Net working capital $ 20 ...

Solution Summary

14-2. Here are book and market value balance sheets of the United Frypan Company (UF):

Book Market

Net working capital $ 20 $ 40 Debt Net working capital $ 20 $ 40 Debt
Long- term assets 80 60 Equity Long- term assets 140 120 Equity
$ 100 $ 100 $ 160 $ 160

Assume that MM's theory holds with taxes. There is no growth, and the $ 40 of debt is expected to be permanent. Assume a 40% corporate tax rate.

a. How much of the firm's value is accounted for by the debt-generated tax shield?
b. How much better off will UF's shareholders be if the firm borrows $20 more and uses it to repurchase stock?

$2.19