Question

In: Finance

The EBIT of a firm is INR 15 crores. The firm is currently allequity financed...

The EBIT of a firm is INR 15 crores. The firm is currently all equity financed at a cost of equity capital of 15%.

The firm intends to lever up and change its capital structure by taking on debt of INR 50 crores in perpetuity as it provides some value add to the firm.

If the prevailing tax rate is 20%, what is the value of this firm before and after the change in capital structure?

The firm is currently efficiently run and the shareholders are happy with the current earnings and do not intend to change the earnings in the future.

Solutions

Expert Solution

The EBIT = 15 crores and it is perpetual, with no growth

first, we will calculate Value of all equity firm OR value of unlevered firm

Value of all equity firm = EBIT*(1-t)/r0 = 15*(1-0.20)/0.15 = 80 crores

Now firm wants to go for perpetual borrowing of 50 crores

Value of Levered firm = Value of all equity firm + Debt*t

Value of levered firm = 80 crores + 50 crores x 0.20 = 90 crores

Answers:

The value of firm before change in capital structure = 80 crores

The value of firm after change in capital structure = 90 crores

jeff jeffy answered 2 years ago
Next > < Previous

Related Solutions

The EBIT of a firm is INR 15 crores. The firm is currently allequity financed...
The EBIT of a firm is INR 15 crores. The firm is currently all equity financed at a cost of equity capital of 15%. The firm intends to lever up and change its capital structure by takingondebtofINR50croresinperpetuityasitprovides some value add to the firm. If the prevailing tax rate is 20%, what is the value of this firm before and after the change in capital structure? The firm is currently efficiently run and the shareholders are happy with the current earnings...
A firm uses INR 50 million of debt, INR 15 million of short-term debt, and INR...
A firm uses INR 50 million of debt, INR 15 million of short-term debt, and INR 90 million of common equity to finance its assets. If the before-tax cost of debt is 10%, after-tax cost of short-term debt is 8%, and the cost of common equity is 16%, calculate the weighted average cost of capital for the firm assuming a tax rate of 20%.
MacKinnon Co. currently has EBIT of $35,000 and is all equity financed. EBIT is expected to...
MacKinnon Co. currently has EBIT of $35,000 and is all equity financed. EBIT is expected to stay at this level indefinitely. The firm pays corporate taxes equal to 20% of taxable income. The cost of equity for this firm is 18%. Suppose the firm has a value of $155,555.56 when it is all equity financed. Now assume the firm issues $71,000 of debt paying interest of 8% per year and uses the proceeds to retire equity. The debt is expected...
Smoke and Mirrors currently has EBIT of $30,000 and is all-equity-financed. EBIT is expected to stay...
Smoke and Mirrors currently has EBIT of $30,000 and is all-equity-financed. EBIT is expected to stay at this level indefinitely. The firm pays corporate taxes equal to 32% of taxable income. The discount rate for the firm’s projects is 8%. a. What is the market value of the firm? (Round your answer to 2 decimal places.)   Market value of the firm   $ b. Now assume the firm issues $40,000 of debt paying interest of 6% per year and uses the...
Trade-Off Theory. Smoke and Mirrors currently has EBIT of $25,000 and is all-equity- financed. EBIT is...
Trade-Off Theory. Smoke and Mirrors currently has EBIT of $25,000 and is all-equity- financed. EBIT is expected to stay at this level indefinitely. The firm pays corporate taxes equal to 21% of taxable income. The discount rate for the firm’s projects is 10%. a. What is the market value of the firm? b. Now assume the firm issues $50,000 of debt paying interest of 6% per year, using the proceeds to retire equity. The debt is expected to be permanent....
A firm has a currentmarketvalueofINR250 crores. The current cost of equity is 15%and the tax rate...
A firm has a currentmarketvalueofINR250 crores. The current cost of equity is 15%and the tax rate is 20 percent. If the firm has announced to issue a per- petual debt of INR 50 crores at 6% interest rate to change the capital structure of the firm, what is the market value of the firm after this announcement?
A firm has a currentmarketvalueofINR250 crores. The current cost of equity is 15%and the tax rate...
A firm has a currentmarketvalueofINR250 crores. The current cost of equity is 15%and the tax rate is 20 percent. If the firm has announced to issue a per- petual debt of INR 50 crores at 6% interest rate to change the capital structure of the firm, what is the market value of the firm after this announcement?
You have come across a project which has an initial investment of INR 5 crores. The...
You have come across a project which has an initial investment of INR 5 crores. The EBIT expected from this project is INR 1 crore in perpetuity, a more stable project with more predictability in the cash flows. Project risk is similar to the business risk of the firm’s core operations. The opportunity cost of capital to the firm if it was an all equity financed firm is 14.5%. The tax rate is 30%. Would you choose this project ?...
A firm is currently 100% equity financed and the beta of its equity is 0.9.
A firm is currently 100% equity financed and the beta of its equity is 0.9. If the firm changes to 20% debt financing and the beta of debt iss 0.1.What will be the beta of its equity after the change in the capital structure?
The Kimberly Corporation is currently a zero growth firm with an expected EBIT of $100,000 and...
The Kimberly Corporation is currently a zero growth firm with an expected EBIT of $100,000 and zero debt financing, and the cost of equity to an unleveled firm in the same risk class is 16.0 percent. (a). No taxes are currently imposed on Kimberly’s earnings. What is the value of the        firm (VU )? (b) Now, assume that Kimberly still pays no taxes but now decides to use $500,000          of 12.0 percent debt financing. Write down (do not calculate)...
ADVERTISEMENT
Subjects
ADVERTISEMENT
Latest Questions
ADVERTISEMENT