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20. Taxes and the Cost of Capital. Here is Icknield's market-value balance sheet (figures in $ millions): Debt Net working capital Long-term assets Value of firm $ 550 2,150 $2,700 Equity $ 800 1,900 $2,700 The debt is yielding 7%, and the cost of equity is 14%. The tax rate is 21%. Investors expect this level of debt to be permanent. (L016-2) a. What is Icknield's WACC? b. How would the market value balance sheet change if Icknield retired all its debt? 30. Trade-Off Theory. Smoke and Mirrors currently has EBIT of $25,000 and is all-equity- financed. EBIT is expected to stay at this level indefinitely. The firm pays corporate taxes equal to 21% of taxable income. The discount rate for the firm's projects is 10%. (L016-3) a. What is the market value of the firm? b. Now assume the firm issues $50,000 of debt paying interest of 6% per year, using the proceeds to retire equity. The debt is expected to be permanent. What will happen to the total value of the firm (debt plus equity)? c. Recompute your answer to part (b) under the following assumptions: The debt issue raises the probability of bankruptcy. The firm has a 30% chance of going bankrupt after 3 years. If it does go bankrupt, it will incur bankruptcy costs of $200,000. The discount rate is 10%. d. Should the firm issue the debt under these new assumptions

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