$80,000 20% 0% 80% 10.0% 10,000 11.0% $48.00 40% 7.0% Volunteer Fabricators, Inc
ID: 2699005 • Letter: #
Question
$80,000
20%
0%
80%
10.0%
10,000
11.0%
$48.00
40%
7.0%
Volunteer Fabricators, Inc. (VF) currently has zero debt. It is a zero growth company, and it has the data shown below. Now the company is considering using some debt, moving to the market value capital structure indicated below. The money raised would be used to repurchase stock. It is estimated that the increase in risk resulting from the additional leverage would cause the required rate of return on equity to rise somewhat, as indicated below.EBIT =
$80,000
New Debt/Value =20%
Growth =0%
New Equity/Value =80%
Orig cost of equity, rs =10.0%
No. of shares =10,000
New cost of equity = rs =11.0%
Price per share =$48.00
Tax rate =40%
Interest rate = rd =7.0%
Explanation / Answer
WACC = We * Re + Wd * rd * (1-Tc)
= 80% * 11% + 20% * 7% * (1-40%) = 9.64%
Taxes on EBIT = 80000 * (0.4) = 32000
Free cash flow = EBIT -depriciation - taxes -expenditure= 80000 - 0 - 32000- 0 = 48000
new value of operations = Free cash flow * (1+g)/(Wacc -g)
= 48000 /9.64%
=497925.31
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