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Return to assets 12% Cost of debt 10% Debt value (perpetuity) 2000 Tax rate 30% Annual...

Return to assets 12%
Cost of debt 10%
Debt value (perpetuity) 2000
Tax rate 30%
Annual pre-tax earnings 600
  1. What would be the value of unlevered company?
  2. What would be the value of levered company?
  3. What is the cost of equity of levered company? (in %)
  4. What would be the value of the unlevered company if a growth rate of g=5% applies
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Answer #1

Value of the unlevered company = value of all equity firm = total value of the firm

= ( pretax earnings * [ 1 - tax rate ] ) / required rate of return

= [ 600 * ( 1 - 30%) ] / 0.12

= 600 * 0.7 / 0.12

=420 / 0.12

= 3500

Value of levered company = Value of unlevered company + value of debt * corporate tax rate

= 3500 + 2000 *0.35 = 3500 + 700 = 4200

value of the unlevered company if a growth rate of g=5% applies

= ( pretax earnings*(1+growth rate) - [ 1 - tax rate ] ) / (required rate of return - growth rate)

= 600*1.05 *( 1 -0.30 ) / ( 0.12 -0.05)

= 441 / 0.07

= 6300

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