Question

Bluegrass Mint Company has a debt-equity ratio of .30. The required return on the company’s unlevered equity is 12 percent and the pretax cost of the firm’s debt is 5.8 percent. Sales revenue for the company is expected to remain stable indefinitely at last year’s level of $18,900,000. Variable costs amount to 70 percent of sales. The tax rate is 23 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? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89)
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.)
c-1.	Use the weighted average cost of capital method to calculate the value of the company. (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89)
c-2.	What is the value of the company’s equity? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89)
c-3.	What is the value of the company’s debt? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89)
d.	Use the flow to equity method to calculate the value of the company’s equity. (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89)

     

Answer 1

	Income statement
	Sales	$       18,900,000
	Variable cost (70% of sales)	$       13,230,000
	EBIT	$         5,670,000
	Tax @23%	$         1,304,100
	Net Income	$         4,365,900
a.	Value of Unlevered firm	EBIT(1-t)/K0
	Value of Unlevered firm (4,365,900/0.12)	$      36,382,500
b.	ke = k0 + (k0-kd) (D/E) * (1-t)
	ke = 12% + (12%-5.8%) (0.30) * (1-0.23)	13.43%
c.	WACC = We*ke + Wd*kd(1-t)
	WACC = ((100/130)*13.4322%) + ((30/130)*5.8%*(1-0.23)	11.36%
	Value of the company (Net Income/WACC)	$       38,421,812
	Value of debt (Vaue of company * Wd)	$        8,866,572
	Value of equity (Value of company - Value of debt)	$      29,555,240
d.	Flow to Equity Method
	Sales	$       18,900,000
	Variable cost (70% of sales)	$       13,230,000
	EBIT	$         5,670,000
	Interest (5.8% of 8866572)	$            514,261
	EBT	$         5,155,739
	Tax @23%	$         1,185,820
	Net Income	$         3,969,919
	Value of Equity (Net income/ke)	$      29,555,240