Question

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 total value of Rent-a-Raptor as an all equity firm, as well as the stock price.

B. Rent-a-Raptor announces that it will issue $150 million of
perpetual riskless debt at a cost of 4% and repurchase $150 million
of equity. Calculate the new total value V_{L} (enterprise
value) of Rent-a-Raptor as a levered firm, total value of equity,
and the new stock price after this debt for equity exchange is
finished.

C. Calculate the new cost of equity and WACC of Rent-a-Raptor as a levered firm.

Answer #1

Find the value of levered equity for this firm.
Assume the firm has perpetual cash flows. Use Miller &
Modigiiani's Proposition II concerning the
cost of equity.
You have the following information about the firm:
EBIT = $100 million
Tax rate - 35%
Debt = $150 million
Cost of debt = 8%
Unlevered cost of capital = 12%

Within the Modigliani Miller framework, under Scenario I (with
no frictional costs, no taxes, and no financial distress), consider
a firm with $40 million in cash flows, initially all equity
financed, and the cost of equity is 13%. If the firm takes on new
debt of $150 million, with a 9% interest rate, what is the new Re
or cost of equity for the firm?
Select one:
a. 13%
b. just over 16%
c. 18.4%
d. 26.5%
e. just under...

Which of the following statements is FALSE?
A. Franco Modigliani and Merton Miller argued that with perfect
capital markets, the total value of a firm should not depend on its
capital structure.
B. Because the cash flows of the debt and equity sum to the cash
flows of the project, by the Law of One Price the combined values
of debt and equity must be equal to the cash flows of the
project.
C. Leverage decreases the risk of the...

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...

Answer the problem based on the framework of Modigliani and
Miller Propositions. Assume that a company has earnings before
interest and taxes (EBIT) of $1,000,000 every year forever. The
firm also has perpetual bonds with the market value of $2,000,000.
The before-tax cost of debt is 8 percent. The firm’s unlevered cost
of capital is 15 percent. The tax rate is 25 percent.
a) Find the value of the firm.
b) Find the value of equity.
c) Find the firm’s...

Discuss Modigliani and Miller's Propositions I and II in a
perfect world without taxes nor distress costs. List the basic
assumptions, results, and intuition of the model. Based on this
model, if the original unlevered firm value is $100 million and the
CFO is planning to carry out a leveraged recapitalization to a debt
equity ratio of 1:1. What’s the levered firm value? If the
unlevered equity requires 10% annual return and the debt requires a
6% of annual return,...

Assume we live in the Modigliani-Miller world of perfect capital
market. Chili Plc is a publicly traded, all-equity financed
company, and has 1 million shares outstanding. Traditionally, Chili
would pay out all its earnings to the shareholders as dividends.
The current annual earnings available to shareholders is £10
million (assuming fixed earnings forever) and Chili’s chief
financial officer (CFO) is exploring alternative options of payout,
and their implications on share price and company value. The first
option is that the...

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...

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...

Trojan Ltd is an all-equity firm subject to a 30 percent tax
rate. Its total market value
is initially $3,500,000. There are 175,000 shares outstanding. The
firm announces a
program to issue $1 million worth of bonds at 10 percent interest
and to use the
proceeds to buy back common stock. Assume that there is no change
in costs of
financial distress and that the debt is perpetual.
Required:
a. What is the value of the tax shield that Trojan...

ADVERTISEMENT

Get Answers For Free

Most questions answered within 1 hours.

ADVERTISEMENT

asked 7 minutes ago

asked 10 minutes ago

asked 22 minutes ago

asked 29 minutes ago

asked 1 hour ago

asked 1 hour ago

asked 1 hour ago

asked 1 hour ago

asked 1 hour ago

asked 1 hour ago

asked 2 hours ago

asked 3 hours ago