Suppose the appropriate discount rate for Kohwe’ s future free cash flows is 8 %, and the only capital market imperfections are corporate taxes and financial distress costs.
a) What is the NPV of Kohwe’ s investment? b) What is Kohwe’ s share price today?
Suppose Kohwe borrows the $ 50 million instead. The firm will pay interest only on this loan each year, and it will maintain an outstanding balance of $ 50 million on the loan. Suppose that Kohwe’ s corporate tax rate is 40 %, and expected free cash flows are still $ 10 million each year.
c) What is Kohwe’ s share price today if the investment is financed with debt?
Now suppose that with leverage, Kohwe’ s expected free cash flows will decline to $ 9 million per year due to reduced sales and other financial distress costs. Assume that the appropriate discount rate for Kohwe’ s future free cash flows is still 8 %.
e) What is Kohwe’ s share price today given the financial distress costs of leverage?