Question

Goodbye Gooday Corporation expects an EBIT of $24,225 every year forever. The company currently has no debt, and its cost of equity is 12.5 percent. The corporate tax rate is 35 percent.

  

a)	What is the current value of the company? (Round your answer to 2 decimal places.)

b)	Suppose the company can borrow at 8 percent. What will the value of the firm be if the company takes on debt equal to 25 percent of its unlevered value? (Round your final answer to 2 decimal places.)

   

c)	What will the value of the firm be if the company takes on debt equal to 75 percent of its levered value? DO NOT use answers for (b) to solve. (Do not round intermediate calculations and round your final answer to 2 decimal places.)

Answer 1

Answer a.

Value of Unlevered Firm = EBIT * (1 - Tax Rate) / Cost of Equity
Value of Unlevered Firm = $24,225 * (1 - 0.35) / 0.1250
Value of Unlevered Firm = $125,970

Answer b.

Value of Debt = 25% * Value of Unlevered Firm
Value of Debt = 25% * $125,970
Value of Debt = $31,492.50

Value of Levered Firm = Value of Unlevered Firm + Tax Rate * Value of Debt
Value of Levered Firm = $125,970 + 0.35 * $31,492.50
Value of Levered Firm = $136,992.40

Answer c.

Value of Debt = 75% * Value of Levered Firm

Value of Levered Firm = Value of Unlevered Firm + Tax Rate * Value of Debt
Value of Levered Firm = $125,970 + 0.35 * 0.75 * Value of Levered Firm
Value of Levered Firm = $125,970 + 0.2625 * Value of Levered Firm
0.7375 * Value of Levered Firm = $125,970
Value of Levered Firm = $170,806.78