Question

In: Finance

There are two firms in the same business: New Co and Old Co. Both are in...

There are two firms in the same business: New Co and Old Co. Both are in the same risk class and each has an EBIT (Earnings Before Interest & Taxes) of $10 million. New Co has no debt and Old Co has $4 million of debt. The New Co cost of equity is 9% and the Old Co cost of debt is 5%. Assume a tax rate of 20%. Calculate the: (a) total value of each firm and (b) the break-down of value or capital structure in terms of its components (debt & equity).

Solutions

Expert Solution

a) Value of New Co =EBIT*(1-Tax Rate)/Cost of Equity =10000000*(1-20%)/9% =88888888.89
Value of Old Co =Value of Unlevered Firm + Debt*Tax Rate =88888888.89+4000000*20% =89688888.89

b) Weight of Equity of New Co. =100%
Weight of debt of New Co. =0%

Weight of Debt of Old Co =4000000/89688888.89=4.46%
Weight of Equity of Old Co =1-4.46% =95.54%

jeff jeffy answered 2 years ago
Next > < Previous

Related Solutions

Salt Co. and Pepper Co. are in the same business and sell the same merchandise but...
Salt Co. and Pepper Co. are in the same business and sell the same merchandise but have different inventory systems: Salt’s is perpetual and Pepper’s is periodic. Both companies sell their products at a price of $10 each, and their inventory activity for March of 2020 is presented below. Salt Date Description # of Units Unit Price Total Cost 02/29/20 Beginning Inventory 50 $1 $50 03/08/20 Purchase 1 50 $2 $100 03/15/20 Sale 90 03/22/20 Purchase 2 50 $3 $150...
The Gecko Company and the Gordon Company are two firms that have the same business risk...
The Gecko Company and the Gordon Company are two firms that have the same business risk but different dividend policies. Gecko pays no dividend, whereas Gordon has an expected dividend yield of 2 percent. Suppose the capital gains tax rate is zero, whereas the income tax rate is 30 percent. Gecko has an expected earnings growth rate of 17 percent annually, and its stock price is expected to grow at this same rate. The aftertax expected returns on the two...
Two wires are made of the same material. If both are at the same temperature, but...
Two wires are made of the same material. If both are at the same temperature, but one has twice the diameter and three times the length of the other, which has the greater resistance, and by what factor? please explain
Ed Co. manufactures two types of O rings, large and small. Both rings use the same...
Ed Co. manufactures two types of O rings, large and small. Both rings use the same material but require different amounts. Standard materials for both are shown. Large Small Rubber 3 feet at $0.25 per foot 1.25 feet at $0.25 per foot Connector 1 at $0.03 1 at $0.03 At the beginning of the month, Ed Co. bought 24,000 feet of rubber for $6,600. The company made 3,000 large O rings and 4,000 small O rings. The company used 14,500...
Ed Co. manufactures two types of O rings, large and small. Both rings use the same...
Ed Co. manufactures two types of O rings, large and small. Both rings use the same material but require different amounts. Standard materials for both are shown. Large Small Rubber 3 feet at $0.25 per foot 1.25 feet at $0.25 per foot Connector 1 at $0.02 1 at $0.02 At the beginning of the month, Ed Co. bought 26,000 feet of rubber for $7,540. The company made 3,000 large O rings and 4,000 small O rings. The company used 14,600...
Korra is 40 years old and Sokka is 20 years old. Both work in the same...
Korra is 40 years old and Sokka is 20 years old. Both work in the same position in the same company and have been laid off permanently. If they enroll together in the same college, to study the same. Given the human capital model, do they have the same net value present?
Consider a portfolio that consists of an equal investment in two firms. For both firms, there...
Consider a portfolio that consists of an equal investment in two firms. For both firms, there is a 10 percent probability that the firms will have a 0% return, and a (1-10) percent probability that they will have a 1% return. The firms' returns are independent of each other. Find the standard deviation of this portfolio. (Answer in % and round to 2 decimal places)
Both competitive market firms and monopoly market firms use the same marginal cost equals marginal revenue...
Both competitive market firms and monopoly market firms use the same marginal cost equals marginal revenue rule to select profit maximizing output, but economists argue that the profit maximizing behavior of competitive firms leads to a socially efficient allocation of resources but that the profit maximizing behavior of a monopoly leads to an inefficient allocation of resources. Explain.
Two identical firms compete in a Bertrand duopoly. The firms produce identical products at the same...
Two identical firms compete in a Bertrand duopoly. The firms produce identical products at the same constant marginal cost of MC = $10. There are 2000 identical consumers, each with the same reservation price of $30 for a single unit of the product (and $0 for any additional units). Under all of the standard assumptions made for the Bertrand model, the equilibrium prices would be Group of answer choices $10 for both firms $30 for both firms $50 for both...
Two firms have the same technology and pay the same wages for labor. They have identical...
Two firms have the same technology and pay the same wages for labor. They have identical factories, but firm 1 paid a higher price for its factory than firm 2 did. They both maximize their profits and have upward-sloping marginal cost curves. Explain whether our theory would predict firm 1 to have a higher output than firm 2.
ADVERTISEMENT
Subjects
ADVERTISEMENT
Latest Questions
ADVERTISEMENT