Question

Hunter Corporation expects an EBIT of $43,000 every year forever. The company currently has no debt and its cost of equity is 11 percent. The corporate tax rate is 21 percent.

  

a.	What is the current value of the company? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
b-1.	Suppose the company can borrow at 8 percent. What will the value of the company be if takes on debt equal to 30 percent of its unlevered value? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
b-2.	Suppose the company can borrow at 8 percent. What will the value of the company be if takes on debt equal to 100 percent of its unlevered value? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
c-1.	What will the value of the company be if takes on debt equal to 30 percent of its levered value? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
c-2.	What will the value of the company be if takes on debt equal to 100 percent of its levered value? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

a)
Value of unlevered firm = EBIT*(1-Corporate tax)/Cost of equity
Unlevered firms are all equity firm, they won't have any debt in their capital structure.
Given that, EBIT=$43000
Cost of equity=11%
Corporate tax rate=21%
Value of unlevered firm = $43000*(1-21%)/11%
So, value of unlevered firm=$43000*(1-.21)/.11=$33970/.11=$308818.18

b1)
We know that, Value of levered firm = Value of unlevered firm +Corporate tax*(Debt)
If debt is 30% of unlevered value, then the debt = 0.30*$308818.18=$92645.454 (where $308818.18 is the unlevered value)
Corporate tax rate=21%
Value of levered firm=$308818.18+ 21%*($92645.454)
=$308818.18+.21*$92645.454
=$308818.18+$19455.54534
So, value of the company=$328273.7253

b-2)
If debt is 100% of unlevered value, then the debt=100%*($308818.18)=$308818.18 (where $308818.18 is the unlevered value)
Corporate tax rate=21%
We know that, Value of levered firm = Value of unlevered firm +Corporate tax*(Debt)
=$308818.18+21%*($308818.18)
=$308818.18+.21*($308818.18)
So, value of the company=$373669.9978

c-1)
Given that, the company takes an amount of debt equal to 30% of its levered value.
If debt is 30% of value of levered firm, then debt will be equal to 30%*(Levered value)

Value of levered firm = Value of unlevered firm +Corporate tax*(Debt)
Let us denote the value of levered firm (or levered value) as VL
Corporate tax rate=21%
Value of levered firm =$308818.18+21%*30%*(Levered value)
=>VL=$308818.18+6.3%VL
=>VL-6.3%VL=$308818.18
=>VL-0.063VL=$308818.18
=>VL*(1-0.063)=$308818.18
=>VL*0.937=$308818.18
=>VL=$308818.18/0.937=$329581.8356
So, Value of the company=$329581.8356

c-2)
Given that, the company takes an amount of debt equal to 100% of its levered value.
If debt is 100% of value of levered firm, then debt will be equal to 100%*(Levered value)
Value of levered firm = Value of unlevered firm +Corporate tax*(Debt)
Let us denote the value of levered firm (or levered value) as VL
Corporate tax rate=21%
Value of the company =$308818.18+21%*100%*(Levered value)
=>VL=$308818.18+21%VL
=>VL-21%VL=$308818.18
=>VL-.21VL=$308818.18
=>VL*(1-.21)=$308818.18
=>VL*(0.79)=$308818.18
=>VL=$308818.18/0.79=$390909.0886