Air Tampa has just been incorporated, and its board of directors is grappling with the question...

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Air Tampa has just been incorporated, and its board of directorsis grappling with the question of optimal capital structure. Thecompany plans to offer commuter air services between Tampa andsmaller surrounding cities. Jaxair has been around for a few years,and it has about the same basic business risk as Air Tampa wouldhave. Jaxair's market-determined beta is 2, and it has a currentmarket value debt ratio (total debt to total assets) of 45% and afederal-plus-state tax rate of 35%. Air Tampa expects to be onlymarginally profitable at start-up; hence its tax rate would only be20%. Air Tampa's owners expect that the total book and market valueof the firm's stock, if it uses zero debt, would be $14 million.Air Tampa's CFO believes that the MM and Hamada formulas for thevalue of a levered firm and the levered firm's cost of capitalshould be used because zero growth is expected. (These are given inequations VL = VU + VTax shield = VU + TD, rsL = rsU + (rsU - rd)(1- T)(D/S), and b = bU[1 + (1 - T)(D/S)].) Estimate the beta of anunlevered firm in the commuter airline business based on Jaxair'smarket-determined beta. (Hint: This is a levered beta; use Equationb = bU[1 + (1 - T)(D/S)] and solve for bU.) Do not roundintermediate calculations. Round your answer to three decimalplaces. Now assume that rd = rRF = 8% and that the market riskpremium RPM = 6%. Find the required rate of return on equity for anunlevered commuter airline. Do not round intermediate calculations.Round your answer to three decimal places. % Air Tampa isconsidering three capital structures: (1) $3 million debt, (2) $6million debt, and (3) $9 million debt. Estimate Air Tampa's rs forthese debt levels. Do not round intermediate calculations. Roundyour answers to two decimal places. Air Tampa's rs for $3 milliondebt: % Air Tampa's rs for $6 million debt: % Air Tampa's rs for $9million debt: % Calculate Air Tampa's rs at $9 million debt whileassuming its federal-plus-state tax rate is now 40%. (Hint: Theincrease in the tax rate causes VU to drop to $10.5 million.) Donot round intermediate calculations. Round your answer to twodecimal places. % Compare this with your corresponding answer topart c. Higher tax rate the financial risk premium at a givenmarket value debt/equity ratio.

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Air Tampa has just been incorporated, and its board of directorsis grappling with the question of optimal capital structure. Thecompany plans to offer commuter air services between Tampa andsmaller surrounding cities. Jaxair has been around for a few years,and it has about the same basic business risk as Air Tampa wouldhave. Jaxair's market-determined beta is 2, and it has a currentmarket value debt ratio (total debt to total assets) of 45% and afederal-plus-state tax rate of 35%. Air Tampa expects to be onlymarginally profitable at start-up; hence its tax rate would only be20%. Air Tampa's owners expect that the total book and market valueof the firm's stock, if it uses zero debt, would be $14 million.Air Tampa's CFO believes that the MM and Hamada formulas for thevalue of a levered firm and the levered firm's cost of capitalshould be used because zero growth is expected. (These are given inequations VL = VU + VTax shield = VU + TD, rsL = rsU + (rsU - rd)(1- T)(D/S), and b = bU[1 + (1 - T)(D/S)].) Estimate the beta of anunlevered firm in the commuter airline business based on Jaxair'smarket-determined beta. (Hint: This is a levered beta; use Equationb = bU[1 + (1 - T)(D/S)] and solve for bU.) Do not roundintermediate calculations. Round your answer to three decimalplaces. Now assume that rd = rRF = 8% and that the market riskpremium RPM = 6%. Find the required rate of return on equity for anunlevered commuter airline. Do not round intermediate calculations.Round your answer to three decimal places. % Air Tampa isconsidering three capital structures: (1) $3 million debt, (2) $6million debt, and (3) $9 million debt. Estimate Air Tampa's rs forthese debt levels. Do not round intermediate calculations. Roundyour answers to two decimal places. Air Tampa's rs for $3 milliondebt: % Air Tampa's rs for $6 million debt: % Air Tampa's rs for $9million debt: % Calculate Air Tampa's rs at $9 million debt whileassuming its federal-plus-state tax rate is now 40%. (Hint: Theincrease in the tax rate causes VU to drop to $10.5 million.) Donot round intermediate calculations. Round your answer to twodecimal places. % Compare this with your corresponding answer topart c. Higher tax rate the financial risk premium at a givenmarket value debt/equity ratio.