Question

Last year Miami Rivet had $5 million in operating income (EBIT). Its depreciation expense was $1 million, its interest expense was $1 million, and its corporate tax rate was 25%. At year-end, it had $14 million in operating current assets, $3 million in accounts payable, $1 million in accruals, $2 million in notes payable, and $15 million in net plant and equipment. Assume Miami Rivet has no excess cash. Miami Rivet uses only debt and common equity to fund its operations. (In other words, Miami Rivet has no preferred stock on its balance sheet.) Miami Rivet had no other current liabilities. Assume that Miami Rivet only non-cash item was depreciation.

Miami Rivet has 500,000 common shares outstanding, and the common stock amount on the balance sheet is $5 million. The company has not issued or repurchased common stock during the year. Last year's balance in retained earnings was $11.2 million, and the firm paid out dividends of $1.8 million during the year.

1. If the firm’s stock price at year-end is $52, what is the firm’s market value added (MVA)?

2. If the firm’s after-tax percentage cost of capital is 9%, what is the firm’s Long-term debt at year-end?

Answer 1

Answer 1) Market Value Added = Market Value of Shares - Book Value of Shareholder's Equity

Market Value of Shares = Market Price of Shares * Shares Outstanding

Market Value of Shares = 52*500,000= 26,000,000

MVA = 26,000,000-5,000,000

MVA = 21,000,000

Answer 2) Interest expenses =1,000,000 After tax cost of capital = 9%

Interest Rate * (1- tax%) = After tax cost of capital

Interest Rate * (1-25%) = 9%

Interest Rate = 12%

Long term debt at year end * 12% = 1,000,000

Long term debt = 8,333,333.33