KN&J expects its EBIT to be $138,000 every year forever. The firm can borrow at

Question

KN&J expects its EBIT to be $138,000 every year forever. The firm can borrow at 10 percent. KN&J currently has no debt and its cost of equity is 17.2 percent. The tax rate is 35 percent. What will the value of KN&J be if the firm borrows $50,000 and uses the loan proceeds to repurchase shares?

A.

B.

D.

KN&J expects its EBIT to be $138,000 every year forever. The firm can borrow at 10 percent. KN&J currently has no debt and its cost of equity is 17.2 percent. The tax rate is 35 percent. What will the value of KN&J be if the firm borrows $50,000 and uses the loan proceeds to repurchase shares?

Explanation / Answer

VU = $ 138000(1-.35)/.172 = $ 521511.63

VL = $ 521511.63+.35($ 50000)= $ 539012

The correct answer is A. $ 539012

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