Answer Happy

Problem 3: Deep See Ventures, a glass bottom boat company in Key Largo and several islands in the Caribbean, currently has an all-equity capital structure. It has an expected operating income of EBIT=$100,000 per year (as a perpetuity) and a corporate tax rate of Tc-40%. The personal tax rate on debt is T₁-30% and the personal tax rate on equity is T₁=15%. Assuming no bankruptcy (or agency/insider information) costs, answer the following questions: A. If equity investors require a 12% return on their after-tax cash flows, what is Deep See currently worth? B. What is the new firm value if Deep See recapitalizes the firm by borrowing $200,000 as perpetual debt at par? The coupon rate on the debt is 5%. (Note: The market value of the debt is $200,000). C. If you learned that the debt is risky and a large proportion of the assets are intangible, would you revise up or down the gain from leverage calculated in 2? Why?