Question Details

perfect capital markets




1. Now consider a DIFFERENT COMPANY in a world that of perfect capital markets, with one change, CORPORATE
TAXES DO EXIST. This world has no personal taxes, all investors have homogeneous expectations, no bankruptcy costs,
and M&M- with corporate taxes theory of capital structure is true. Company Y is financed has the following market
value balance sheet:
Assets = $ 110 Liabilities = $0
Equity = $110
The firm had $20 in EBIT last year. The firm has 20 shares outstanding. The firm expects the same return/profits for
the foreseeable future. The firm a is a zero growth firm, that pays out all excess earnings as dividends. Any time the firm
changes its capital structure, it changes only the debt/equity mix and does not change its physical/fixed assets.
Liabilities consist only of the firm- debt. The debt is riskless, perpetual, selling at par, and has a 8% pre-tax yield. If the
firm were to change its capital structure, new debt would still have a 8% pre-tax yield. The firm- tax rate is 35%. Given
this information, answer the following questions:
a. (3 points) What is the current weighted average cost of capital (WACC)?

b. (3 points) What is the firm- current dividends per share?

Now assume the firm issue $100 in debt and repurchases $100 in equity.
c. (3 points) Write out the firm- new balance sheet after all of the changes.

d. (3 points) What is the firm- Weighted Average Cost of Capital?




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