Question

Mojito Mint Company has a debt–equity ratio of .30. The required return on the company’s unlevered equity is 13 percent, and the pretax cost of the firm’s debt is 7.8 percent. Sales revenue for the company is expected to remain stable indefinitely at last year’s level of $18,300,000. Variable costs amount to 60 percent of sales. The tax rate is 34 percent, and the company distributes all its earnings as dividends at the end of each year.

  

a.	If the company were financed entirely by equity, how much would it be worth? (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

  

Value of the company

$

  

b.	What is the required return on the firm’s levered equity? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

  

Required return

%

  

c-1.	Use the weighted average cost of capital method to calculate the value of the company. (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

  

Value of the company

$

  

c-2.	What is the value of the company’s equity? (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

  

Value of equity

$

  

c-3.	What is the value of the company’s debt? (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

  

Value of debt

$

  

d.	Use the flow to equity method to calculate the value of the company’s equity. (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

  

Value of equity

$

Answer 1

Sales=18,300,000

VC is 60%=10,980,000

contribution=7,320,000

less tax=2,488,800

Net operating income=4,831,200

Divided by un-levered cost of equity=/.13

Value of firm=37,163,077

b)r0 = the required return on the equity of an unlevered firm
rS        = the required return on the equity of a levered firm
rB        = the pre-tax cost of debt
                            TC    = the corporate tax rate
                           B/S = the firm’s debt-to-equity ratio

Rs=Ro + (B/S) (Ro-Rb) (1-Tc)

= 0.13+[.30*(0.13-0.078) (1-0.34)]

=.14

c)

WACC=[10/13*14%]+[3/13*7.8*(1-0.34)]

=10.77%+1.19%

=11.96%

d)Value of equity=(10/13)*37,163,077

=28,586,982