Recession Expected Expansion
(prob. = .2) (prob. = .5) (prob. =.3)
EBIT $10,000 $20,000 $30,000
MV Assets ______ ______ ______
(a) Complete the table above if the company is 100% equity financed and the non-levered return on equity is expected to be 12%
(b) If the company pays tax at a 30% rate and it wants to recapitalize (debt for equity swap) to save on taxes, what is the most debt the company can add (at a 6% rate) so that it will never go bankrupt under the above scenarios? (Assume the company goes bankrupty if EBIT < Interest owed)
(c) Calculate the WACC for the unlevered case and for the result in part (b).
(d) What is the market value of the assets if the firm chooses the debt level in part (b)?
(e) If further analysis suggests that the following can be used to predict the cash flows of the company: EBIT = $1500 x random number chosen from 1 to 20
What is the optimal deb/equity ratio if the company wants to limit the probability of bankruptcy to 5% or less?
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