The AB300 Company is identical to the BA720 Company (information in previous pro
ID: 2716286 • Letter: T
Question
The AB300 Company is identical to the BA720 Company (information in previous problem) in every respect save two: it is debt free and its cost of equity is 11.5%.
a) What is the value of the AB300 Company?
b) Explain the difference in values for AB300 versus BA320.
(Previuos Problem - The BA720 Company has $15 million in pretax income, a tax rate of 30%, and a capital structure mix that is comprised of 78% in equity and 22% million in long term debt [market value basis]. The cost of debt is 9% and cost of equity is 12%.)
Explanation / Answer
Answer:a) Calculation of the value of AB300 company:
Pretax income=$15 million
Less: Tax @30%=$4.5 million
After tax income=$10.5 million
Value of company=$10.5 million/0.115=$91.30 million
Answer:b) BA720 value:
Pretax income=$15 million
Less: Tax @30%=$4.5 million
After tax income=$10.5 million
Value of company=$10.5 million/0.1134=$92.59 million
WACC=0.09*0.22+0.12*0.78=0.0198+0.0936=11.34%
Difference in value=BA720-AB300
=$92.59 million-91.30 million
=$1.29 million
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