Question

Assume a Modigliani and Miller world. All cash flows are perpetuities. Parts A, B, and C...

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 VL (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.

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