Question

Young Corporation expects an EBIT of $25,250 every year forever. The company currently has no debt, and its cost of equity is 12 percent. The corporate tax rate is 35 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.)

  

Company value

$

  

b-1.	Suppose the company can borrow at 7 percent. What will the value of the company be if it takes on debt equal to 40 percent of its unlevered value? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

  

Company value

$

  

b-2.	Suppose the company can borrow at 7 percent. What will the value of the company be if it 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.)

  

Company value

$

  

c-1.	What will the value of the company be if it takes on debt equal to 40 percent of its levered value? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

  

Company value

$

  

c-2.	What will the value of the company be if it 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.)

  

Company value

$

Answer 1

Answer a.

Unlevered Value = EBIT * (1 - tax) / Cost of Equity
Unlevered Value = $25,250 * (1 - 0.35) / 0.12
Unlevered Value = $136,770.83

Answer b-1.

Value of Debt = 40% * Unlevered Value
Value of Debt = 40% * $136,770.83
Value of Debt = $54,708.33

Levered Value = Unlevered Value + Value of Debt * tax
Levered Value = $136,770.83 + 0.35 * $54,708.33
Levered Value = $155,918.75

Answer b-2.

Value of Debt = 100% * Unlevered Value
Value of Debt = 100% * $136,770.83
Value of Debt = $136,770.83

Levered Value = Unlevered Value + Value of Debt * tax
Levered Value = $136,770.83 + 0.35 * $136,770.83
Levered Value = $184,640.62

Answer c-1.

Value of Debt = 40% * Levered Value

Levered Value = Unlevered Value + Value of Debt * tax
Levered Value = $136,770.83 + 0.40 * Levered Value * 0.35
Levered Value = $136,770.83 + 0.14 * Levered Value
0.86 * Levered Value = $136,770.83
Levered Value = $159,035.85

Answer c-2.

Value of Debt = 100% * Levered Value

Levered Value = Unlevered Value + Value of Debt * tax
Levered Value = $136,770.83 + 1.00 * Levered Value * 0.35
Levered Value = $136,770.83 + 0.35 * Levered Value
0.65 * Levered Value = $136,770.83
Levered Value = $210,416.66