Question

The A. J. Croft Company (AJC) currently has $200,000 market value (and book value) of perpetual debt outstanding carrying a coupon rate of 6 percent. Its earnings before interest and taxes (EBIT) are $100,000, and it is a zero-growth company. AJC's current unlevered beta is 0.5, and its tax rate is 40 percent. The firm has 10,000 shares of common stock outstanding selling at a price per share of $60.00. The firm is considering moving to a capital structure that is comprised of 40 percent debt and 60 percent equity, based on market values. The new funds would be used to replace the old debt and to repurchase stock. It is estimated that the increase in riskiness resulting from the leverage increase would cause the required rate of return on debt to rise to 7 percent. The risk free rate is 6 percent and the market risk premium is 5 percent.

What would be its new total market value of debt and total market value of equity respectively?

Answer #1

EBIT = $100,000

Unlevered beta = 0.5

levered beta = unlevered beta * ( 1 + (1 - tax rate) * (debt / equity) )

= 0.5 * ( 1 + (1 - 0.40) * ( 0.40 / 0.60)

Levered beta = 0.7

New cost of debt = 7%

New cost of equity = Rf + beta * market risk premium

= 6% + 0.7 * 5%

Cost of equity = 9.5%

New WACC = Cost of debt * Weight of debt * (1 - tax rate) + Cost of equity * weight of equity

= 7% * 0.40 * (1- 0.40) + 9.5% * 0.60

New WACC = 7.38%

Value of firms = EBIT (1 - tax rate) / WACC

= 100000 ( 1- 0.40) / 7.38%

= 60,000 / 0.0738

Value of firm = $ 813,008.13

Debt value = Value of firm * 0.40 = $ 325,203.252

Equity value = value of firm - value of debt = $ 813,008.13 - 325,203.252 = 487,804.878

The A. J. Croft Company (AJC) currently has $200,000 market
value (and book value) of perpetual debt outstanding carrying a
coupon rate of 6 percent. Its earnings before interest and taxes
(EBIT) are $100,000, and it is a zero-growth company. AJC's current
unlevered beta is 0.5, and its tax rate is 40 percent. The firm has
10,000 shares of common stock outstanding selling at a price per
share of $60.00. The firm is considering moving to a capital
structure that...

The Anson Jackson Court (AJC) currently has $200,000 market
value (and book value) of perpetual debt outstanding carrying a
coupon rate of 4%. Its earnings before interest and taxes (EBIT)
are $89,000, and it is a zero growth company. AJC's current cost of
equity is 8%, and its tax rate is 25%. The firm has 10,000 shares
of common stock outstanding selling at a price per share of $60.00.
Refer to the data for the Anson Jackson Court Company (AJC)....

Powell Plastics, Inc. (PP) currently has zero debt. Its earnings
before interest and taxes (EBIT) are $80,000, and it is a zero
growth company. PP’s current cost of equity is 10%, and its tax
rate is 40%. The firm has 10,000 shares of common stock outstanding
selling at a price per share of $48.00. PP is considering moving to
a capital structure that is comprised of 30% debt and 70% equity,
based on market values. The debt would have an...

An all equity firm is expected to generate perpetual EBIT of
$100 million per year forever. The corporate tax rate is 35%. The
firm has an unlevered (asset or EV) Beta of 0.8. The risk-free rate
is 4% and the market risk premium is 6%. The number of outstanding
shares is 10 million. The firm decides to replace part of the
equity financing with perpetual debt.
2) The firm will issue $100 million of permanent debt at the
riskless interest...

Best Bagels, Inc. (BB) Best Bagels, Inc. (BB) currently has zero
debt. Its earnings before interest and taxes (EBIT) are $100,000,
and it is a zero growth company. BB's current cost of equity is
13%, and its tax rate is 40%. The firm has 20,000 shares of common
stock outstanding selling at a price per share of $23.08. Refer to
the data for Best Bagels, Inc. (BB). BB is considering moving to a
capital structure that is comprised of 20%...

An all equity firm is expected to generate perpetual EBIT of
$100 million per year forever. The corporate tax rate is 35%. The
firm has an unlevered (asset or EV) Beta of 0.8. The risk-free rate
is 4% and the market risk premium is 6%. The number of outstanding
shares is 10 million.
The firm decides to replace part of the equity financing with
perpetual debt. The firm will issue $100 million of permanent debt
at the riskless interest rate...

Assume a Modigliani and Miller world. All cash flows are
perpetuities. Parts A, B, and C below are 6, 6, and 8
points respectively.
Rent-a-Raptor is 100% equity financed. The firm is expected to
have perpetual EBIT of $70 million per year. The unlevered equity
or asset Beta is 1.0. The riskless rate is 4%, and the market risk
premium is 6%. There are 10 million shares of common stock
outstanding. The corporate tax rate is 40%.
A. Calculate the...

Domino, Inc. is an unlevered firm with a total market value of
$5,880,000 with 200,000 shares of stock outstanding. The firm has
expected EBIT of $414,000 if the economy is normal and $760,000 if
the economy booms. The firm is considering a $2,000,000 bond issue
with an attached interest rate of 6.2 percent. The bond proceeds
will be used to repurchase shares. Ignore taxes. What will the
earnings per share be after the repurchase if the economy
booms?

An all equity firm is expected to
generate perpetual EBIT of $50 million per year forever. The
corporate tax rate is 0% in a fantasy no tax world. The firm has an
unlevered (asset or EV) Beta of 1.0. The risk-free rate is 5% and
the market risk premium is 6%. The number of outstanding shares is
10 million.
2. The firm
decides to replace part of the equity financing with perpetual
debt. The firm issues $100 million of permanent...

Isabella Publishing's tax rate is 21%, its beta is 1.40, and it
currently has no debt. The CFO is considering moving to a capital
structure with 25% debt and 75% equity and using the newly raised
capital to repurchase shares of the common stock. If the risk-free
rate is 4.5% and the market risk premium is 7.0%, by how much would
the cost of equity for the levered firm increase, compared to the
cost of equity of the unlevered firm?...

ADVERTISEMENT

Get Answers For Free

Most questions answered within 1 hours.

ADVERTISEMENT

asked 1 minute ago

asked 1 minute ago

asked 20 minutes ago

asked 30 minutes ago

asked 32 minutes ago

asked 40 minutes ago

asked 41 minutes ago

asked 44 minutes ago

asked 44 minutes ago

asked 57 minutes ago

asked 1 hour ago

asked 1 hour ago