Letang Corporation expects an EBIT of $22,000 every year forever. The company cu
ID: 2734127 • Letter: L
Question
Letang Corporation expects an EBIT of $22,000 every year forever. The company currently has no debt, and its cost of equity is 15.5 percent. The company can borrow at 9.5 percent and the corporate tax rate is 40.
What is the current value of the company? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)
(a) 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).)
(b) 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).)
(a) 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).)
(b) 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).)
Letang Corporation expects an EBIT of $22,000 every year forever. The company currently has no debt, and its cost of equity is 15.5 percent. The company can borrow at 9.5 percent and the corporate tax rate is 40.
Explanation / Answer
Requirement 1:-
The Current value of firm = EBIT (1 - Tax) / Cost of equity
= 22000 (1 - 0.40) / 0.155
= 13200 / 0.155
= $ 85161.29 (approx)
Conclusion:- Current value of firm = $ 85161.29 (approx).
Requirement 2:-
a) The value of the firm if the company takes on debt equal to 50 percent of its unlevered value:-
= Value of unlevered firm + Debt * Tax rate
= 85161.29 + (85161.29 * 0.50) * 0.40
= 85161.29 + 42580.645 * 0.40
= 85161.29 + 17032.258
= $ 102193.55 (approx)
Conclusion:-The value of the firm if the company takes on debt equal to 50 percent of its unlevered value will be $ 102193.55 (approx).
b) The value of the firm if the company takes on debt equal to 100 percent of its unlevered value:-
= Value of unlevered firm + Debt * Tax rate
= 85161.29 + 85161.29 * 0.40
= $ 119225.81 (approx)
Conclusion:-The value of the firm if the company takes on debt equal to 100 percent of its unlevered value will be $ 119225.81 (approx).
Requirement 3
a) The value of the firm if the company takes on debt equal to 50 percent of its levered value:-
Let Levered value be L.
Levered value = Value of unlevered firm + Debt * Tax rate
L = 85161.29 + (L * 0.50) * 0.40
L = 85161.29 + 0.50 L * 0.40
L = 85161.29 + 0.2 L
0.8 L = 85161.29
L = 85161.29 / 0.8
L = $ 106451.61 (approx)
Conclusion:-The value of the firm if the company takes on debt equal to 50 percent of its levered value will be $ 106451.61 (approx).
b) The value of the firm if the company takes on debt equal to 100 percent of its levered value:-
Let Levered value be L.
Levered value = Value of unlevered firm + Debt * Tax rate
L = 85161.29 + L * 0.40
L = 85161.29 + 0.40 L
0.60 L = 85161.29
L = 85161.29 / 0.60
L = $ 141935.48 (approx)
Conclusion:-The value of the firm if the company takes on debt equal to 100 percent of its levered value will be $ 141935.48 (approx).
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