Theory and Taxes DataCore Inc. currently has an all-equity capital structure. However, the firm is considering a recapitalization that would structure the firm with 25% debt and 75% equity by issuing an appropriate amount of debt and repurchasing an equal amount of common stock; the debt is expected to have a 5% coupon rate. The firm expects the following scenarios over the next year for EBIT Outlook Probability EBIt
Good 35% 800000
Average 40% 525000
Poor 25% 75000
The firm currently has 200,000 shares of common stock outstanding at $43 per share. The firm is in a 0% tax bracket.
1. Determine the expected earnings before interest and taxes, net income, and earnings per share (a) if the firm maintains its current unlevered capital structure and (b) if it recapitalizes at 25% debt and uses the proceeds to repurchase conm
2. Following the assumptions behind M&M's Proposition I, calculate the stockholders' required rate of return of the firm in an unlevered versus a levered state. Calculate the value of the levered firm, separating it into debt and equity components. Also, calculate the weighted average cost of capital (WACC) for the firm in a levered versus an unlevered state. 3. Assuming the firm is in a 35% corporate tax bracket, determine the value of the unlevered firm versus the value of the levered firm.