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Unlev Inc., an unlevered firm, has perpetual expected earnings before interest and taxes of $6.6 million...

Unlev Inc., an unlevered firm, has perpetual expected earnings before interest and taxes of $6.6 million per year, a tax rate of 34.00% and a beta of 1.5. The risk-free rate is 3.75% and the market risk-premium is 5.50%. Management is considering buying some of its stock back through an issue of debt. The firm will be issuing 5,280 bonds at a coupon rate of 7.00%. The face value of a bond = $1,000. The bonds will be offered at par.

a. What is the cost of equity of the unlevered firm?

b. What is the value of the unlevered firm?

c. What is the value of the levered firm?

d. What is the levered firm’s cost of capital?

e. Which firm (levered or unlevered) has the highest value? Discuss how leverage affects the value of a firm and whether it is optimal for firms to maintain a 100% leverage structure?

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jeff jeffy answered 6 months ago
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