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%

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...

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Within the Modigliani Miller framework, under Scenario I (with
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An all equity firm is expected to generate perpetual EBIT of
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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
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