Question

In: Finance

Alpha Corporation has earnings before interest and tax (EBIT) per annum in perpetuity of $200,000. The...

Alpha Corporation has earnings before interest and tax (EBIT) per annum in perpetuity of $200,000. The tax rate is 30%. The firm is funded $50,000 of debt and $150,000 of equity. The cost of equity is 18% and the cost of debt is 6%.

Given the information above, what is the appropriate discount rate if earnings after interest and before tax (EAIBT)is used to calculate the equity value of the firm?

A.

20.79%

B.

25.71%

C.

18%

D.

14.55%

E.

None of the above

Solutions

Expert Solution

Answer-

When calculating equity value, levered free cash flows ie. cash flow available to equity shareholders are discounted by the cost of equity because the calculation is only concerned with what is left for equity investors.

Therefore the Correct Option is C. 18 %

Here Weighted average ost of capital (WACC) is not used as enterprise value, unlevered free cash flows ie. cash flow available to all shareholders are discounted by WACC as it includes what is available to all investors.

here WACC = Wt of debt x cost of debt x ( 1 - tax rate) + Wt of equity x cost of equity

WACC = 0.25 x 6 % x ( 1 - 0.3) + 0.75 x 18 %

[ Wt of debt = $ 50000 / ( $ 50000 + $150000) = $50000 / $ 200000 = 0.25 / Total capital = $ 50000 + $150000 = $ 200000 ]

WACC = 0.25 x 6 % x 0.7 + 0.75 x 18 %

WACC = 1.05 % + 13.5 %

WACC = 14.55 %

Here WACC cannot be used to calculate the equity value of the firm

Therefore option D is incorrect. Options A and B are incorrect.


Related Solutions

Alpha Corporation has earnings before interest and tax (EBIT) per annum in perpetuity of $200,000. The...
Alpha Corporation has earnings before interest and tax (EBIT) per annum in perpetuity of $200,000. The tax rate is 30%. The firm is funded $50,000 of debt and $150,000 of equity. The cost of equity is 18% and the cost of debt is 6%. Given the information above, what is the appropriate discount rate if earnings before interest and tax (EBIT) are used to calculate the value of the firm? A. 20.79% B. 25.71% C. 18% D. 14.55% E. None...
Alpha Corporation has earnings before interest and tax (EBIT) per annum in perpetuity of $200,000. The...
Alpha Corporation has earnings before interest and tax (EBIT) per annum in perpetuity of $200,000. The tax rate is 30%. The firm is funded $50,000 of debt and $150,000 of equity. The cost of equity is 18% and the cost of debt is 6%. Given the information above, what is the appropriate discount rate if earnings before interest and after tax (EBIAT) are used to calculate the value of the firm? A. 20.79% B. 25.71% C. 18% D. 14.55% E....
What is Earnings Before Interest and Taxes-Earnings Per Share (EBIT-EPS) analysis? What is the indifference curve?...
What is Earnings Before Interest and Taxes-Earnings Per Share (EBIT-EPS) analysis? What is the indifference curve? How is risk factored into the EBIT-EPS analysis? What are basic shortcomings of EBIT's analyses?
Suppose E-M Corp. (EMC) has perpetual earnings before interest and taxes (EBIT) of $10 million per...
Suppose E-M Corp. (EMC) has perpetual earnings before interest and taxes (EBIT) of $10 million per year. E-M’s unlevered cost of equity is 12%. EMC is subject to a corporate tax rate of 40%. It has $30 million in permanent debt in its capital structure, and the (pre-tax) cost of debt is 7% (EAR). What is the after-tax WACC of E-M Corp.? Select one: 7.99% 9.12% 7.79% 12.00% 14.80% 9.68% 10.49% 8.58%
1. The Awesome Fun Conglomerate has earnings before interest and taxes (EBIT) of $58,218 and net...
1. The Awesome Fun Conglomerate has earnings before interest and taxes (EBIT) of $58,218 and net income (NI) of $4,042. The tax rate is 24 percent. What is the times interest earned ratio? A. 0.08 B. 1.10 C. 8.90 D. 2.49 E. 1.26 2. Global Logistics has sales of $783,200, cost of goods sold of $312,900, and inventory of $174,315. What is the inventory turnover rate? A. 17.37 times B. .9 times C. 2.71 times D. 3.4 times E. 1.79...
Billco Corporation expects earnings before interest and taxes to be $450,000 for the current tax year....
Billco Corporation expects earnings before interest and taxes to be $450,000 for the current tax year. Using the U.S. corporate flat tax rate of 21%, compute the Billco’s earnings available for common stockholders if the firm pays $25,000 in interest versus $25,000 in preferred stock dividends. Answers: A.) $371,000; $347,000 B.) $357,080; $357,080 C.) $335,750; $330,500 D.) $376,040; $352,040
Sunrise, Inc., has no debt outstanding and a total market value of $200,000. Earnings before interest...
Sunrise, Inc., has no debt outstanding and a total market value of $200,000. Earnings before interest and taxes, EBIT, are projected to be $13,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 15 percent higher. If there is a recession, then EBIT will be 30 percent lower. The company is considering a $70,000 debt issue with an interest rate of 7 percent. The proceeds will be used to repurchase shares of...
Castle, Inc., has no debt outstanding and a total market value of $200,000. Earnings before interest...
Castle, Inc., has no debt outstanding and a total market value of $200,000. Earnings before interest and taxes, EBIT, are projected to be $30,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 18 percent higher. If there is a recession, then EBIT will be 20 percent lower. The firm is considering a debt issue of $75,000 with an interest rate of 8 percent. The proceeds will be used to repurchase shares...
Pendergrast, Inc., has no debt outstanding and a total market value of $200,000. Earnings before interest...
Pendergrast, Inc., has no debt outstanding and a total market value of $200,000. Earnings before interest and taxes, EBIT, are projected to be $24,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 15 percent higher. If there is a recession, then EBIT will be 30 percent lower. Pendergrast is considering a $70,000 debt issue with an interest rate of 7 percent. The proceeds will be used to repurchase shares of stock....
RAK, Inc., has no debt outstanding and a total market value of $200,000. Earnings before interest...
RAK, Inc., has no debt outstanding and a total market value of $200,000. Earnings before interest and taxes, EBIT, are projected to be $26,000 if economic conditions are normal. If there is strong expansion in the economy, then EBIT will be 12 percent higher. If there is a recession, then EBIT will be 25 percent lower. RAK is considering a $65,000 debt issue with an interest rate of 6 percent. The proceeds will be used to repurchase shares of stock....
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT