Question

Juicy Fruits and Deserts expects to earn $365,000 in perpetuity before interest and taxes from its line of candies.The company has debt worth $774,242.40.The company has a debt to assets ratio of 40 percent.The cost of debt is 10 percent.If the company has no debt, its cost of capital would have been 15 percent.The firm’s tax rate is 30 percent. What is the value of the firm? What is the value of its equity? What is the required rate of return on equity? Calculate the WACC of Juicy Fruits and Deserts

Answer 1

Solutions:

1.Value of the Firm

Debt to assets ratio=Total Debt/Total assets

Total assets=Total Debt/Debt to assets ratio

=$774,242.40/40%

=$1935,606

(Book)Value of the Firm=Total Assets-total liablities

=$1935,606-$774,242.40

=$1161,363.60

Thus value of firm is $1161,363.60

2.value of Equity shall be equal to value of the firm,thus value of equity will be $1161,363.60

3.Required rate of return on equity(ke)

Calculation of required return:

Annual Income = $365,000

Less: Interest($774,242.40*10%) =77424.24

Income Before Tax =$287575.76

Less:Tax @30% =$86272.73

Required Return for Equity =$201,303.03

Required rate of return on equity=Required Return for Equity /Value of equity

=$201303.03/$1161,363.60

=17.33%

4.Calculation the WACC

Weight of Equity=Value of equity/(Value of equity+Value of Debt)

=$1161,363.60/($774,242.40+$1161,363.60)

=$1161,363.60/$1935,606.00

=60%

Weight of Debt=100%-Weight of Equity

=100%-60%

=40%

WACC=Ke*Weght of Equity+Cost of Debt(1-tax rate)*Weight of Debt

=17.33%*.60+10(1-.30)*.40

=10.398%+2.80

=13.20%