1) The market value of XYZ Company is given below:
VDO = $40.00 (Value of Debt)
VEO = $120.00 (Value of Equity)
Tax rate is 40% and interest is tax deductible. Company is perpetual steady state company. At present debt is yielding 8%.
a) How much of firm's value is accounted for by debt generated subsidy?
b) How much better off will shareholders be if firm borrows $20 more and uses it to repurchase stock? Interest rate will be 10% with this higher debt level.
c) Now assume that a government passes the law which will phase out deductibility of interest for tax purposes after period of five years. What will the new value of firm be, all other things remaining equal?
2) Bi-Lo Traders is considering the project which will produce sales of= $28,000 and raise cash expenses by $17,500. If project is implemented, taxes will raise by $3,000. Additional reduction expense will be= $1,600. Initial cash outlay of $1,400 is needed for net working capital. Determine the amount of operating cash flow by using the top-down approach?