Question

Hunter Corporation expects an EBIT of $27,000 every year forever. The company currently has no debt and its cost of equity is 13 percent. The corporate tax rate is 23 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 7 percent. What will the value of the company be if takes on debt equal to 60 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 7 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.)

Answer 1

a. Calculation of Current Value of the Company

Current Value of the Company= EBIT(1-T) / Overall Cost(ko)

here EBIT= $27000

Tax Rate=23%

Overall Cost=Cost of Equity =13%

Given that company has no debt ,so it is all eqity firm therefore Cost of Equity is also overall cost.

Current Value of Company =27000(1-.23) / .13

=$159923.08

Therefore Value of Company=$159923.08.

b-1) Calculation of Value of Company

Given that company borrow 60% of its unlevered value,therefore

Value of Debt=60% *Value of Unlevered firm

=60%*159923.08

=$95953.85.

Note: Given that company has no debt, therefore value of unlevered firm=$159923.08

Value of Company will be

Under Modigliani-Miller Approach,

VL=VU+Tax rate∗D
Where,
VL = Value of Levered Firm
VU = Value of Unlevered Firm
D = Value of Debt

VL =$159923.08 +.23 * 95953.85

=$181992.47

Therefore ,the value of the company be if takes on debt equal to 60 percent of its unlevered value is $181992.47

b-2) Calculation of Value of Company

Given that company borrow 100% of its unlevered value,therefore

Value of Debt=100% *Value of Unlevered firm

=100%*159923.08

=$159923.08

Note: Given that company has no debt, therefore value of unlevered firm=$159923.08

Value of Company will be

VL=VU+Tax rate∗D
Where,
VL = Value of Levered Firm
VU = Value of Unlevered Firm
D = Value of Debt

VL =$159923.08 +.23 * 159923.08

=$196705.39

Therefore the value of the company be if takes on debt equal to 100 percent of its unlevered value is $196705.39.