Assume the following selected financial information about a firm that is about to restructure capital by exchanging equity for debt: $\begin{array}{ll}
\text { Present debt level }&=\$0\
\text { Proposed equity for debt swap }&=\$1,500,000\
\text { Interest rate on debt }&=6\%\\text { Corporate tax rate }&=40\%\\text { Market value of the firm's ecuity }&=\$2,400,000
\end{array}$
Which of following would be true as a result of the restructuring according to the Modigliani-Miller model with taxes but without bankruptcy costs?
A) The new debt would contribute $600,000 to the value of equity due to its tax effect.
B) The market value of the remaining equity would be $1,500,000.
C) The total value of the firm would increase to $3,000,000.
D) All of the above.

Question

Assume the following selected financial information about a firm that is about to restructure capital by exchanging equity for debt: $\begin{array}{ll}
\text { Present debt level }&=\$0\
\text { Proposed equity for debt swap }&=\$1,500,000\
\text { Interest rate on debt }&=6\%\\text { Corporate tax rate }&=40\%\\text { Market value of the firm's ecuity }&=\$2,400,000
\end{array}$
 Which of following would be true as a result of the restructuring according to the Modigliani-Miller model with taxes but without bankruptcy costs?
A) The new debt would contribute $600,000 to the value of equity due to its tax effect.
B) The market value of the remaining equity would be $1,500,000.
C) The total value of the firm would increase to $3,000,000.
D) All of the above.

Quizplus · Accepted Answer

The Modigliani-Miller model with taxes but without bankruptcy costs predicts that the total value of the firm will remain the same after the restructuring. The new debt will contribute $600,000 to the value of equity due to its tax effect, and the market value of the remaining equity will be $1,500,000.

Assume the Following Selected Financial Information About a Firm That