Question

Change Corporation expects an EBIT of $53,000 every year forever. The company currently has no debt, and its cost of equity is 15 percent. The corporate tax rate is 21 percent.

a. What is the current value of the company? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) b-1. Suppose the company can borrow at 12 percent. What will the value of the firm be if the company takes on debt equal to 50 percent of its unlevered value? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) b-2. Suppose the company can borrow at 12 percent. What will the value of the firm be if the company takes on debt equal to 100 percent of its unlevered value? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) c-1. What will the value of the firm be if the company takes on debt equal to 50 percent of its levered value? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) c-2. What will the value of the firm be if the company takes on debt equal to 100 percent of its levered value? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

a)

Value of unlevered firm = EBIT(1−TC)/R0

= $53,000(1 - 0.21)/0.15 = $279,133.33

b-1)

VL = VU + tCB

If debt is 50% of value of unlevered firm, then debt = 0.50 VU

VL = VU + tC(0.50VU)

= $279,133.33 + (0.21)(0.50)($279,133.33) = $279,133.33 + $29,309 = $308,442.33

b-2)

If debt is 100% of value of unlevered firm, then debt = 1.0 VU

VL = VU + tC(1.0VU)

= $279,133.33 + (0.21)(1.00)($279,133.33) = $279,133.33 + $58,618 = $337,751.33

c-1)

If debt is 50% of value of levered firm, then debt = 0.50 VL

VL = VU + tC(0.50VL)

VL = $279,133.33 + (0.21)(0.50)(VL)

VL - 0.105VL = $279,133.33

0.895VL = $279,133.33

VL = $279,133.33 / 0.895 = $311,880.82

c-2)

If debt is 100% of value of levered firm, then debt = 1.0 VL

VL = VU + tC(1.0VL)

VL = $279,133.33 + (0.21)(1.0)(VL)

VL - 0.21VL = $279,133.33

0.79VL = $279,133.33

VL = $279,133.33 / 0.79 = $353,333.33