Two firms, No Leverage, Inc., and High Leverage, Inc., have equal levels of operating risk and differ only in their capital structure. No Leverage is unlevered and High Leverage has $500,000 of perpetual debt in its capital structure.
Assume that the perpetual annual income of both firms available for stockholders is paid out as dividends. Hence, the growth rate for both firms is zero. The income tax rate for both firms is 40 percent. Assume that there are no financial distress costs or agency costs. Given the following data:
Determine the:
a. Market value of no Leverage, Inc.
b. Market value of High Leverage, Inc.
c. Present value of the tax shield to High Leverage, Inc.