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An unlevered company with a cost of equity of 15% generates $7 million in earnings before...

An unlevered company with a cost of equity of 15% generates $7 million in earnings before interest and taxes (EBIT) each year. The decides to alter its capital structure to include debt by adding $2 million in debt with a pre-tax cost of 8% to its capital structure and using the proceeds to reduce equity by a like amount as to keep total invested capital unchanged. The firm pays a tax rate of 39%.

Assuming that the company's EBIT stream can be earned into perpetuity and that the debt can be perpetually issued (or rolled), what is the value of the equity of the levered company?

An unlevered company with a cost of equity of 16% generates $4 million in earnings before interest and taxes (EBIT) each year. The decides to alter its capital structure to include debt by adding $2 million in debt with a pre-tax cost of 4% to its capital structure and using the proceeds to reduce equity by a like amount as to keep total invested capital unchanged. The firm pays a tax rate of 39%.

Assuming that the company's EBIT stream can be earned into perpetuity and that the debt can be perpetually issued (or rolled), what is the firm's new debt-to-equity ratio?

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SEE THE IMAGE. ANY DOUBTS, FEEL FREE TO ASK. THUMBS UP PLEASE

jeff jeffy answered 2 years ago
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