Problem 1: Grommit Engineering expects to have net income next year of $20.75 million and free cash flow of $22.15 million. Grommit’s marginal corporate tax rate is 35%.
a) If Grommit increases leverage so that its interest expense rises by $1million, how will its net income change.
b) For the same increase in interest expense, how will free cash flow change?
Problem 2: Your firm currently has $100 million in debt outstanding with a 10% interest rate. The terms of the loan require the firm to repay $25 million of the balance each year. Suppose that the marginal corporate tax rate is 40%, and that the interest tax shields have the same risk as the loan.
What is the present value of the interest rate shields from this debt?
Problem 3: Milton Industries expects free cash flow of $5million each year. Milton’s corporate tax rate is 35%, and its unleveled cost of capital is 15%. The firm also has outstanding debt of $19.05 milllion and it expects to maintain this level of debt permanently.
a. What is the value of Milton Industries without leverage?
b. What is the value of Milton Industries with leverage?
Problem 4: With its current leverage, Impi Corporation will have net income next year of $4.5 million. If Impi’s corporate tax rate is 35% and it pays 8% interest on its debt, how much additional debt can Impi issue this year and still receive the benefit of the interest tax shield next year?