Jet Corporation expects an EBIT of $21,000 every year forever. The company curre

Question

Jet Corporation expects an EBIT of $21,000 every year forever. The company currently has no debt, and its cost of equity is 12 percent. The corporate tax rate is 35 percent.

What will the value of the firm be if the company takes on debt equal to 50 percent of its levered value?

What will the value of the firm be if the company takes on debt equal to 100 percent of its levered value?

Jet Corporation expects an EBIT of $21,000 every year forever. The company currently has no debt, and its cost of equity is 12 percent. The corporate tax rate is 35 percent.

What will the value of the firm be if the company takes on debt equal to 50 percent of its levered value?

What will the value of the firm be if the company takes on debt equal to 100 percent of its levered value?

Explanation / Answer

VAlue of Firm if the company takes on debt equal to 100 % of leveraged value

VAlue of Firm = Net operating profit afer tax /WACC

NOPAT = EBIT(1-tax rate)

NOPAT = 21000x(1-35%) =13650

WACC = 12x(1-35%) =7.8

Value of Firm = 13650/7.8% =$175000

WHen the company takes on debt equal to 50% of its leveraged value

NOPAT = 13650

WACC = 12x50%+6x(1-35%)x50% =6 +1.95 =7.95

Value of firm = 13650/7.95% =171698.10

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