Question

Simmons Mineral Operations, Inc. is a company that has no debt and that has a forecasted EBIT of $372,000 perpetually. Right now the cost of equity of Simmons Mineral Operations, Inc. is 13.6 percent and the corporate tax rate is 39 percent. The firm is in the process of selling $988,000 worth of perpetual bonds with an annual interest rate of 5.6 percent at par. What is the value of Simmons Mineral Operations, Inc. after it issues debt?

What is the value of Simmons Mineral Operations, Inc. after it issues debt?

• $1,501,676

• $1,953,885

• $2,053,849

• $1,668,529

• $1,853,922

Answer 1

Solution:-

Value of unlevered firm = EBIT * (1-Tax rate) / Cost of equity

Given,

EBIT = $372,000

Cost of equity = 13.6% or 0.136

Tax rate = 39% or 0.39

Value of unlevered firm = $372,000 * (1-39%)/13.6%

= $372,000 * 61% / 13.6%

= $1,668,529.41176

Value of levered firm = Value of unlevered firm + (debt * tax rate)

= $1,668,529.41176 + ($988,000 * 39%)

= $1,668,529.41176 + $385,320

= $2,053,849.41176 (approx $2,053,849)

Therefore the value of Simmons mineral operations inc, after isseuins of debt is $2,053,849 which is option 3.