In This Problem, We Admit Only One Real-World Factor in an Otherwise

question 6

Multiple Choice

In this problem, we admit only one real-world factor in an otherwise ideal capital market.This real world factor is corporate taxation; specifically that interest payments on debt are deductible while dividend payments are not deductible.Suppose Delaware East, Inc.has until now been an all-equity firm with a market value of $100 mn.Now, the firm decides to increase its leverage by issuing $40 mn.in debt, with the proceeds being used to pay a dividend to shareholders.Assuming that this debt will be a permanent part of the firm's capital structure, and that the firm's tax rate is 34%, and accounting for the deductibility of the interest on the debt, what is the total market value of the firm after the recapitalization?

• A)$113.6 mn.
• B)$100 mn.
• C)$73.6 mn.
• D)$13.6 mn.

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A unit of length in the United States customary and British imperial systems, equal to one-twelfth of a foot or exactly 2.54 centimeters.

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