Question

Bluegrass Mint Company has a debt-equity ratio of .25. The required return on the company’s unlevered equity is 11.9 percent and the pretax cost of the firm’s debt is 5.7 percent. Sales revenue for the company is expected to remain stable indefinitely at last year’s level of $18,800,000. Variable costs amount to 65 percent of sales. The tax rate is 22 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

a. Value of Company = Net income / Return

Value of Company = Sales * (1 - VC %) * (1 - Tax) / 11.9%

Value of Company = 18800000 * (1 - 0.65) * (1 - 0.22) / 11.9%

Value of Company = 5132400 / 11.9%

Value of Company = $43129411.76

b. Required Return = Equity Return + DE Ratio * (Equity - Debt) * (1 - Tax)

Required Return = 11.9% + 0.25 * (11.9% - 5.70%) * (1 - 0.22)

Required Return = 11.9% + 1.21%

Levered Equity Return = 13.11%

c. WACC

Value of Company = Net Income / WACC = 5132400 / 0.1041 = $49302593.66

C-2. Value of Company's Equity = 49302593.66 * 1 / 1.25 = $39442074.93

C-3. Value of Company's Debt = 49302593.66 * 0.25 / 1.25 = $9860518.73

d. value of the company’s equity

Company's Equity = Net Income / Levered Equity

Company's Equity = 5132400 - Interest * (1 - Tax) / Levered Equity

Company's Equity = 5132400 - 562049.57 * (1 - 0.22) / 13.11%

Company's Equity = 4694001.34 / 13.11%

Company's Equity = 35804739.41