Question

3.
Five J
Ventures Co.
has and
expected perpetual EBITDA of
$83,000
per
year.
It’s borrowing
cost is8%;
but
has no
debt.
Its cost
of unlevered
equity is
13%.

a.
If the tax
rate is 35%, what is the value of the firm? (25
pts)

b.
What will be
value of the firm be if it borrows $125,000 and uses the proceeds
to repurchase shares?

c.
What is the
value of the equity of the levered
firm?

please give
formulas and full work.

Answer #1

EBITDA = $83000

Since the firm has no debt

EBT = $83000

Tax Rate = 35%

Tax amount = 35% * 83000 = 29050

Earnings after tax = $83000 - $29050 = $53950

A) Value of the firm = Earnings after tax / cost of equity

= 53950 / 13%

= $415000

B) Since the firm is all equity

Equity of the firm = $41500

Debt infused = $125000

Borrowing cost = 8%

EBITDA = $83000

Interest on debt = 125000 * 8% = $10000

EBT = $83000 - $10000 = $73000

Tax = 73000 * 35% = $25550

Earning after tax = $47450

Since the funds are used to repurchase equity ,

New equity of the firm = $415000 - $125000 = $290000

Debt = $125000

Value of the levered firm = Equity + liabilities = $290000 + $125000 = $415000

C) The value of equity of the levered firm = Earning After Tax / Cost of equity

= 47450 / 13%

= $365000

Value of equity of the levered firm is $365000

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