Question

Given the following information. Equity    Corporation Debt      Corporation Cost of equity 9% 2.7% Debt -------- $600000...

Given the following information.

Equity    Corporation

Debt      Corporation

Cost of equity

9%

2.7%

Debt

--------

$600000

Pretax cost of debt

--------

10%

EBIT

$150000

$  150000

Calculate the market value of Equity Corporation, Debt Corporation, and the present value of the tax shield to Debt Corporation if both companies have a tax rate of 40%. Assume there are no financial distress or agency costs and that expected growth of EBIT is zero.

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Answer #1

Equity corporation

debt corporation

EBIT

150000

150000

less interest

0

60000

EBT

150000

90000

less taxes- 40%

60000

36000

EAT

90000

54000

value of equity = EAT/cost of equity

1000000

2000000

Interest tax shield

interest *tax rate

60000*40%

24000

present value of interest tax shield

24000/1.0346

23197.37

WACC for Debt corporation

source

value of investment

weight

cost

weight*cost

debt

600000

0.230769

6

1.384615

equity

2000000

0.769231

2.7

2.076923

total

2600000

WACC

sum of weight*cost

3.46
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