Cavo Corporation expects an EBIT of $27,000 every year forever. The company curr

Question

Cavo Corporation expects an EBIT of $27,000 every year forever. The company currently has no debt, and its cost of equity is 14 percent. The corporate tax rate is 35 percent.

What is the current value of the company? (Round your answer to 2 decimal places. (e.g., 32.16))

Suppose the company can borrow at 9 percent. What will the value of the firm be if the company takes on debt equal to 40 percent of its unlevered value? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Suppose the company can borrow at 9 percent. What will the value of the firm be if the company takes on debt equal to 100 percent of its unlevered value? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

What will the value of the firm be if the company takes on debt equal to 40 percent of its levered value? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

What will the value of the firm be if the company takes on debt equal to 100 percent of its levered value? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Cavo Corporation expects an EBIT of $27,000 every year forever. The company currently has no debt, and its cost of equity is 14 percent. The corporate tax rate is 35 percent.

Explanation / Answer

a.

What is the current value of the company? (Round your answer to 2 decimal places. (e.g., 32.16))

  Current value = EBIT*(1-tax rate)/Cost of Capital

Current value = 27000*(1-35%)/14%

Current value = $ 125,357.14

Answer

  Current value $ 125,257.14

b-1

Suppose the company can borrow at 9 percent. What will the value of the firm be if the company takes on debt equal to 40 percent of its unlevered value? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

  Value of the firm = VU + tCD

Value of the firm = 125,257.14 + 35%*(40%*125257.14)

Value of the firm = 142,793.14

Answer

  Value of the firm $   142,793.14

b-2

Suppose the company can borrow at 9 percent. What will the value of the firm be if the company takes on debt equal to 100 percent of its unlevered value? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Levered value = VU + tCD

Levered value = 125,257.14 + 35%*(100%*125257.14)

Levered value = 169,097.14

  Levered value $ 169,097.14

c-1

What will the value of the firm be if the company takes on debt equal to 40 percent of its levered value? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

  Value of the firm =  EBIT*(1-tax rate)/Cost of Capital

Cost of capital = 60%*14 + 40%*9*(1-35%)

Cost of capital = 10.74%

  Value of the firm = 27000*(1-35%)/10.74%

Value of the firm = $ 163,407.82

Answer

  Value of the firm $ 163,407.82

c-2

What will the value of the firm be if the company takes on debt equal to 100 percent of its levered value? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Levered value =  EBIT*(1-tax rate)/Cost of Capital

Cost of capital = 0%*14 + 100%*9*(1-35%)

Cost of capital = 5.85%

Levered value = 27000*(1-35%)/5.85%

Levered value = $ 300,000

Answer

  Levered value $ 300,000

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