Corporate Finance, Module 17

Homework Assignment

(The attached PDF file has better formatting.)

A project with an indefinite life has an initial investment of $10 million.

The opportunity cost of capital is 12% with all-equity financing, the borrowing rate is 8%, and the firm borrows $4 million against the project.

●    The debt is perpetual; it is refinanced each year.
●    The corporate tax rate is 35%.

A.    What is the interest paid in each year?
B.    What is the present value of the debt tax shields if the debt is fixed at $4 million?
C.    If the debt is re-balanced each year to a fixed percentage of the project’s value, is the present value of the debt tax shield higher or lower? Explain why.

For Part C, see page 537 of the textbook (14th edition).