Carter Co. has a value of $70 million. Buleigh is otherwise identical to Carter
ID: 2719897 • Letter: C
Question
Carter Co. has a value of $70 million. Buleigh is otherwise identical to Carter Co., but has $28 million in debt. Suppose that both firms are growing at a rate of 6%, the corporate tax rate is 38%, the cost of debt is 8%, and Carter's cost of equity is 13% (assume rsU is the appropriate discount rate for the tax shield).
Use the Modigliani and Miller theory extension for growth to complete the following table:
Carter Co. Burleigh Co.
Value of firm Given: $70 mill Select from: $82.16 mill, $79.44 mill, 77.57 mill, or $80.80 mill
Value of Stock Given: $70 mill Select from: $52.80 mill, $49.57 mill, $54.16 mill, or $51.44 mill
Cost of Equity Given 13% Select from: 15.72%, 15.59%, 15.65%, or 15.82%
Explanation / Answer
Burleigh Co.
1)
Tax shield of interets on Debt = 28 Million * 8%*38% = 0.8512 Million
Value of firm = Value of Unlevered Firm + Present Value of Tax shield of interets on Debt
Value of firm = 70 + 0.8512/(13%-6%)
Value of firm = $ 82.16 Million
2)
Value of Stock = Value of firm - Value of Debt
Value of Stock = 82.16 - 28
Value of Stock = $ 54.16 Million
3)
EBT = 70*(13%-6%) = 4.90 Million
NOPAT = EBT of Unlevered Firm
Cost of Capital of Burleigh Co. = NOPAT/Value of Firm + growth rate
Cost of Capital of Burleigh Co. = 4.9/82.16 + 6%
Cost of Capital of Burleigh Co. = 11.9639%
Cost of Equity = (Cost of Capital of Burleigh Co. - Weight of Debt * After tax cost of Debt)/Weight of Equity
Cost of Equity = (11.9639 - 28/82.16*8*(1-38%))/(54.16/82.16)
Cost of Equity = 15.59%
Answer
Burleigh Co.
Value of firm = $82.16 million
Value of Stock = $54.16 million
Cost of Equity = 15.59%
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