Question

1) Company U has no debt outstanding currently and the cost of equity is 12%. Its EBIT is expected to be $ 186335 every year forever. The tax rate is 35%.

Calculate the value of the firm.

2) Continuing with previous question.

Company U has no debt outstanding currently and the cost of equity is 12%. Its EBIT is expected to be $ 186335 every year forever. The tax rate is 35%.

Calculate the value of the firm if it borrows $ 434273 and uses the proceeds to repurchase the shares. Company U can borrow at 6% (cost of debt

3) Continuing with previous question.

Company U has no debt outstanding currently and the cost of equity is 12%. Its EBIT is expected to be $ 186335 every year forever. The tax rate is 35%.

Firm borrows $ 434273 and uses the proceeds to repurchase the shares. Company U can borrow at 6% (cost of debt).

What is the debt to equity ratio of the company after the change in the capital structure? Express you answer as %.

Answer 1

Given

Cost of Equity (Ke) = 12%

EBIT = 186,335 dollars

Tax Rate = 35%

(a)

NOPAT = EBIT*(1-Tax) = 186335*(1-35%) = 121,117.75 dollars

Value of the firm = NOPAT / Cost of Capital = 121117.75/0.12 = 1,009,314.5833 dollars

(b)

Value of the firm from previous question = 1,009,315 dollars

Debt Infused into the company = 434,273 dollars

Value of equity = 1009315 - 434273 = 575,042 dollars

CALCULATION OF WEIGHTED AVERAGE COST OF CAPITAL(WACC)
Sources	Value	Weights	Cost	WACC
Debt	434273	0.43026508	3.900%	0.016780338
Equity	575042	0.56973492	12%	0.06836819
TOTAL	1009315			8.5149%

Value of the Enterprise = NOPAT/Cost of Capital = 121117.75/0.085149 = 1,422,421.2850 dollars.

(c)

Value of the Enterprise= 1,422,421.2850 dollars

Value of Equity = Value of Enterprise - Debt =1,422,421.2850  - 434273 = 988,148.2850 dollars

Value of Debt = 434,273 dollars

Debt/Equity = 434273/988,148.2850= 0.439482 or 43.9482%