As a consultant to First Responder Inc., you have obtained the following data (d
ID: 2654008 • Letter: A
Question
As a consultant to First Responder Inc., you have obtained the following data (dollars in millions). The company plans to pay out all of its earnings as dividends, hence g = 0. Also, no net new investment in operating capital is needed because growth is zero. The CFO believes that a move from zero debt to 55.0% debt would cause the cost of equity to increase from 10.0% to 13.0%, and the interest rate on the new debt would be 8.0%. What would the firm's total market value be if it makes this change? Hints: Find the FCF, which is equal to NOPAT = EBIT(1 - T) because no new operating capital is needed, and then divide by (WACC - g).
$800
40.0%
13.00%
55.0%
8.00%
Oper. income (EBIT)$800
Tax rate40.0%
New cost of equity (rs)13.00%
New55.0%
Interest rate (rd)8.00%
Explanation / Answer
WACC = Weighatge of debt * Cost of debt * (1 - tax rate) + Weighatge of equity * Cost of equity
= 55% * 8% * (1 - 40%) + 45% * 13%
= 8.49%
Value of firm = EBIT * (1 - tax rate) / WACC
= $800 * (1 - 40%) / 8.49%
= $5,653.71
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