4. You have the following information about Ledd—a publicly traded (and therefore infinitely lived) company:
Operating income: $20 million
Cost of unlevered equity: 10%
Risk-free interest rate: 5%
Corporate marginal tax rate: 0
a. If Ledd is financed entirely by equity,
i. What is the value of the firm?
1. 200 million (w/o tax) ; 200 million(with tax)
ii. What is the return required by stockholders?
1. 10% (w/o tax) ;10% (with tax)
iii. What is the company’s WACC?
1. 10% (w/o tax) ; 10% (with tax)
b. Ledd decides to issue bonds with the market value of 40% of total assets, using the proceeds to repurchase equity. The bonds are considered to be risk-free.
i. What is the value of Ledd with the new capital structure?
1. 200 million (w/o tax);228.8 million (with tax)
ii. What is the return required by stockholders of the leveraged firm?
1. 6% or 13.33% (w/o tax); 13.21%(with tax)
iii. What is the WACC?
1. 8% or 10% (w/o tax); 9.21%(with tax)
iv. What is the tax shield of debt?
1. 0 (w/o tax) ; 28.8 million (with tax)
c. The government implements a marginal corporate tax rate of 36%.
i. Recalculate your answers to a) and b) in a world with taxes.
1. Shown Above (2nd Answer)