Question

Hunter Corporation expects an EBIT of $29,000 every year forever. The company currently has no debt and its cost of equity is 14 percent. The corporate tax rate is 24 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 8 percent. What will the value of the company be if takes on debt equal to 30 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 8 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.)
c-1.	What will the value of the company be if takes on debt equal to 30 percent of its levered value? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
c-2.	What will the value of the company be if takes on debt equal to 100 percent of its levered value? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

a. What is the current value of the company?

Answer: 157,428.57

Calculation:

Here, we need to calculate the value of the company. For that we need to multply the earnings before interest and tax to the tax rate and then divide it with the cost of equity.

Here, EBIT = 29,000

T_c; is thecorporate tax rate = 24 percent

R_u is the cost of equity = 14 percent

So, current value of the company = (29,000 x (1-24%)) / 14% = 22,040 / 14% = 157,428.57

b-1. Suppose the company can borrow at 8 percent. What will the value of the company be if takes on debt equal to 30 percent of its unlevered value?

Answer: 168,763.43

Calculation:

Here, we need to calculate the levered value of the company.

The levered firm value with the debt is 30%. of its unlevered value is

We have already calculated V_u in the required (a).

T_c; is thecorporate tax rate = 24 percent

D; is the debt which is 30%.

Levered value of the company = 157,428.57 x (1+ 30% x 24%) = 168,763.43

b-2. Suppose the company can borrow at 8 percent. What will the value of the company be if takes on debt equal to 100 percent of its unlevered value?

Answer: 195,211.43

Calculation:

Here, we need to calculate the levered value of the company.

The levered firm value with the debt is 100%. of its unlevered value is

We have already calculated V_u in the required (a).

T_c; is thecorporate tax rate = 24 percent

D; is the debt which is 100%.

Levered value of the company = 157,428.57 x (1+ x 24%) = 195,211.43

c-1. What will the value of the company be if takes on debt equal to 30 percent of its levered value?

Answer:  169,642.86

Calculation:

Here, we need to calculate the levered value of the company.

The levered firm value with the debt is 30% of its levered value is

We have already calculated V_u in the required (a).

T_c; is thecorporate tax rate = 24 percent

D; is the debt which is 30% of levered value

Levered value of the company = 157,428.57 / (1 - 24% x 30%) = 169,642.86

c-2. What will the value of the company be if takes on debt equal to 100 percent of its levered value?

Answer: 207,142.86

Calculation:

Here, we need to calculate the levered value of the company.

The levered firm value with the debt is 100% of its levered value is

We have already calculated V_u in the required (a).

T_c; is thecorporate tax rate = 24 percent

D; is the debt which is 100% of levered value

Levered value of the company = 157,428.57 / (1 - 24%) = 207,142.86