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Hanover Industries has expected earnings before interest and taxes of $630,300, an unlevered cost of equity...

Hanover Industries has expected earnings before interest and taxes of $630,300, an unlevered cost of equity of 14.7 percent, and a combined tax rate of 23 percent. The company also has 11,000 senior bonds outstanding that carry a coupon rate of 7 percent. The debt is selling at par value. What is the value of this company? What is the target capital structure of the firm if the levered cost of equity is 17.25? Assume MM with taxes holds.

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Answer #1

Value of Unlevered Firm = EBIT * (1 - Tax) / Unlevered cost of capital

Value of Unlevered Firm = 630300 * (1 - 0.23) / 14.7%
Value of Unlevered Firm = $3301571.43

Value of Levered Firm = Value of Unlevered Firm + Debt * tax

Value of Levered Firm = 3301571.43 + 11000000 * 0.23

Value of Levered Firm = $5831571.43

Target DE Ratio =

Cost of Levered Equity = Cost of Unlevered Equity + (Cost of Unlevered Equity - Cost of Debt)* Debt * (1 - tax)/Equity

17.25% = 14.70% + (14.70% -7%) * (1 - 0.23) D/E

D/E = 0.1725 / .20629

D/E = 0.84

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