Question
An unlevered company with a cost of equity of 18% expects to generate $5 million in...
An unlevered company with a cost of equity of 18% expects to generate $5 million in earnings before interest and taxes (EBIT) each year into perpetuity. The firm pays a tax rate of 28%.
Based on its after-tax earnings and cost of equity, what is the value of the firm?
An unlevered company with a cost of equity of 16% generates $6 million in earnings before interest and taxes (EBIT) each year. The decides to alter its capital structure to include debt by adding $2 million in debt with a pre-tax cost of 7% to its capital structure and using the proceeds to reduce equity by a like amount as to keep total invested capital unchanged. The firm pays a tax rate of 39%.
Assuming that the company's EBIT stream can be earned into perpetuity and that the debt can be perpetually issued (or rolled), what is the value of the firm?
Homework Answers
Answer #1
| particulars | amount IS $ M |
| EBIT | 5 |
| LESS TAX@28% | 1.4 |
| EAT | 3.6 |
VALUE OF FIRM =
=$22.5 M
2)VALUE OF LEVERED FIRM
| particulars | amount IS $ M |
| EBIT | 6 |
| LESS INTEREST 2M*7% | 0.14 |
| EBT | 5.86 |
| LESS TAX@39% | 2.2854 |
| EAT | 3.7146 |
VALUE OF EQUITY
=
=$23.21625 M
GIVEN VALUE OF DEBT IS $2 M
VALUE OF FIRM=VALUE OF EQUITY + VALUE OF DEBT
=23.21625+2
VALUE OF FIRM=$25.21625M
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