Letang Corporation expects an EBIT of $21, 250 every year forever. The company c
ID: 2734121 • Letter: L
Question
Letang Corporation expects an EBIT of $21, 250 every year forever. The company currently has no debt, and its cost of equity is 14 percent. The company can borrow at 8 percent and the corporate tax rate is 40. Requirement 1: What is the current value of the company? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).) Value of the firm $ 91071.43 Requirement 2: What will the value of the firm be if the company takes on debt equal to 50 percent of its unlevered value? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).) Value of the firm $ 109285.72 What will the value of the firm be if the company takes on debt equal to 100 percent of its unlevered value? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).) Value of the firm $ 127500.002 Requirement 3: What will the value of the firm be if the company takes on debt equal to 50 percent of its levered value? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).) Value of the firm $_______What will the value of the firm be if the company takes on debt equal to 100 percent of its levered value? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).) Value of the firm $_______Explanation / Answer
1. Value of the firm = Value of Equity + Value of debt
Value of Equity = Earnings available to equity shareholders/cost of equity
= EBIT - TAX RATE/COST OF EQUITY = 21,250 - 40% /14% = 91071.43
Value of the Firm = Value of equity only (as there is no debt) = $ 91071.43
2. Value of Equity = value of unlevered firm = 91071.43
Value of Debt = 91071.43 x 50% = 45535.72
Interest on Debt = 45535.72 x 8% = 3,642.86
Interest after tax = 3,642.86(100%-40%) = 2185.72
Value of Debt = Interest after tax/rate of interest = 2185.72/0.08 = 27321.45
Value of Equity = Residual earnings or earnings avaiblable to equity shareholders/cost of equity
= EBIT - Interest after ta - 40%/Cost of equity = 21250 - 2185.71 - 40%/0.14
= 11438.57/0.14=81704.1
Value of the firm = Value of equity + value of debt = 81704.1 + 27321.45 = 109025.55
b. Value of the firm if the company takes on debt equal to 100 percent of unlevered value
Unlevered vlaue of the firm = 91071.43
Debt = 91071.43
Interest = 91071.43 x 8% = 7285.71
Interest after tax = 7285.71 - 40% = 4371.43
Value of debt = 4371.43/0.08 = $54642.86
Value of equity = EBIT - Interest after tax - 40%/cost of equity
21250 - 4371.43 - 40%/0.14 = 72,336.73
Value of the firm = value of equity + value of debt = 72,336.73 + 54,642.86 = 126979.59
3(a) Value of the firm be if company takes on 50% of levered value
50% of levered value = debt = 109285.72
Interest on debt = 109285.72 x 8% = 8742.86
Interest after tax = 8748.86 - 40% = 5245.71
Value of debt = Interest after tax/rate of interest = 5245.71/0.08 = $65571.43
Value of equity = EBIT - Interest after tax - 40%/cost of debt = 21250 - 5245.71 - 40%/0.14 = $68589.81
Value of firm = Value of equity + value of debt = 68,589.81 + 65571.43 = $134161.24
3.(b) Value of the firm be if company takes on debt equal to 100% of levered value
100% of levered value = Debt = 126,979.59
Interest = 126,979.59 x 8% = 10,158.37
Interest after tax = 10158.37 - 40% = 6095.02
Value of debt = interest after tax/rate of interest = 6095.02/0.08 = $76,187.75
Value of Equity = EBIT - Interest after tax - 40%/cost of equity = 21250 - 6095.02 - 40% /0.14 = 64,949.91
Value of the firm = Value of equity + value of firm = $64,949.91 + 76,187.75 = 141,137.66
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