Question

Cavo Corporation expects an EBIT of $23,000 every year forever. The company currently has no debt, and its cost of equity is 15 percent. The corporate tax rate is 35 percent.

a. What is the current value of the company? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Company value $

b-1. Suppose the company can borrow at 11 percent. What will the value of the company be if it takes on debt equal to 50 percent of its unlevered value? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Company value $

b-2. Suppose the company can borrow at 11 percent. What will the value of the company be if it takes on debt equal to 100 percent of its unlevered value? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Company value $

c-1. What will the value of the company be if it takes on debt equal to 50 percent of its levered value? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Company value $

c-2. What will the value of the company be if it takes on debt equal to 100 percent of its levered value? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Company value $

Answer 1

a. Value of the company = EBIT*(1-tax rate)/ cost of equity = 23,000*(1-0.35)/0.15 = $99,666.67

b-1 Expression for Leverged firm is: Vl = Vu + Tc* D = 99,666.67 + 0.35*0.5*99666.67 = $117,108.34

b-2 Expression for Leverged firm is: Vl = Vu + Tc* D = 99,666.67 + 0.35*1*99666.67 = $134,550

c-1 Vl = Vu + TcD = Vu + Tc*(0.6* Vl)

Vl= 99.666.67 + 0.35*0.6* Vl

Vl =99,666.67/ (1-0.35*0.6) = $126,160.34

c-2 Vl = Vu + TcD = Vu + Tc*(1* Vl)

Vl= 99.666.67 + 0.35*1* Vl

Vl =99,666.67/ (1-0.35*1) = $153.333.34