Question 1 a) AFD Company currently has earnings before interest and taxes of M2,500,000. The company is financed entire

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Question 1 A Afd Company Currently Has Earnings Before Interest And Taxes Of M2 500 000 The Company Is Financed Entire 1 (51.14 KiB) Viewed 23 times

Question 1 a) AFD Company currently has earnings before interest and taxes of M2,500,000. The company is financed entirely by equity. The earnings are not expected to change anytime in the foreseeable future. The company pays corporate taxes equal to 35% of taxable income. The discount rate for the company's projects is 10%. i. Compute the market value of AFD Company. (4) ii. Assume that the company issues a permanent debt of M5,000,000, paying interest of 6% per year, and using the proceeds to retire equity. State what will happen to the total value of AFD Company, supporting your answer with relevant computations. (5) iii. Assume that after the issue of the debt in (ii) above AFD Company realizes that the debt issue raises the possibility of bankruptcy. In fact, the company figures out that it has a 30% chance of going bankrupt after three years. If it does go bankrupt, it will incur bankruptcy costs of M20,000,000. The discount rate remains 10%. Was it wise for AFD Company to issue the debt? Motivate your answer with appropriate computations. (6) b) Discuss the Pecking order theory of optimal capital structure. 3