Question

Simmons Inc. has an expected net income of 4 million Euros at the end of the year. The company is currently all equity financed but it is planning to buy back equity and undertake some debt so that the debt- to-equity ratio will become 0.5. The debt-to-equity ratio will be kept constant. The assets will be fully depreciated in the next three years, with annual depreciation installments of 1,000,000 Euro each. The company does not plan to acquire any asset. The expected return on unlevered equity for Simmons is 9.25% and the cost of debt is 5.25%. The tax rate on corporate earnings is 32%. What is the value of Simmons’ debt, if the expected EBITDA of the company is perpetual and constant every year? (Assume that the depreciation tax shield is as risky as the rest of the unlevered cash flow)

(a) 15,829,380 Euro
(b) 16,032,251 Euro
(c) 17,987,342 Euro
(d) 18,223,172 Euro

The answer is D: 18,223,171 Euro
Thumb up for correct step-by-step solution. Many thanks.

Answer 1

solution :

given that Rundle Freight Company owns a truck that cost $33,000.

also given that Currently, the truck’s book value is $27,000, and its expected remaining useful life is five years

mentioned in gi ven indormation that

Rundle has the opportunity to purchase for $28,000 a replacement truck that is extremely fuel efficient. Fuel cost for the old truck is expected to be $7,000 per year more than fuel cost for the new truck.

some other given information The old truck is paid for but, in spite of being in good condition, can be sold for only $16,000.

Calculating the total relevant costs:

	retaining truck	replacing truck
cost of the new truck	$-	$28000
additional fuel cost (5*7000)	$35000	$-
oppurtunity cost	$16000	$-
total cost	$51000	$28000

final decision of retaining old truck :

the purchase cost of ol;d truck and book value are irrelevant

they are sunk cost

therefore they should not be considered

the comparision cost of replacing and retaining truck are given above

from the above table

the company should replace the old truck as it would cost $28000 in replacement as against the cost of reraining truck of $51000