Can someone help me with this Corporate Finance Problem??
HappyLand will have a free cash flow of $12 million in one year, and you expect the firm's free cash flows to grow by a costant rate in subsequent years.
Using the following data and under the hypothesis of permanent debt find the interest tax shield.
rf 0,04
D/E 0,65
r(e) 0,11
r(d) 0,065
Stock price 1,2
Number shares 15000
Equity book value 12500
Wacc 0,083
An easy way to do it would be to use the D/E ratio and equity book value to find a dollar book value of debt. Then using your r(d) which I assume is the cost of debt, you can find an approximate value of interest expenses on this book value of debt. This tax-deductible interest expense value will be the value of your interest tax shield.
First you have to decide how to structure the problem. In the case of a fixed level of debt, the formula is simply DrT/r or DT. In the case of a fixed capital structure, the formula is Dr*T/ra - g where ra is the unlevered cost of equity. You can derive the unlevered cost of equity with Modigliani Miller proposition #1.
Now, you're given the D/E ratio, the book value of equity (not useful unless you want to use a RIV model to determine the market value of equity), the FCF in period t1 and the cost of equity. You can determine the level of debt by: Use gordon growth, the FCF in t1 and the WACC to determine EV and impute the corresponding levels of debt and equity from the given D/E ratio
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