3. value: 16.66 points Levered, Inc., and Unlevered, Inc., are identical in ever
ID: 2753692 • Letter: 3
Question
3.
value:
16.66 points
Levered, Inc., and Unlevered, Inc., are identical in every way except their capital structures. Each company expects to earn $29.3 million before interest per year in perpetuity, with each company distributing all its earnings as dividends. Levered’s perpetual debt has a market value of $94 million and costs 8 percent per year. Levered has 2.6 million shares outstanding, currently worth $108 per share. Unlevered has no debt and 4.8 million shares outstanding, currently worth $83 per share. Neither firm pays taxes.
Levered, Inc., and Unlevered, Inc., are identical in every way except their capital structures. Each company expects to earn $29.3 million before interest per year in perpetuity, with each company distributing all its earnings as dividends. Levered’s perpetual debt has a market value of $94 million and costs 8 percent per year. Levered has 2.6 million shares outstanding, currently worth $108 per share. Unlevered has no debt and 4.8 million shares outstanding, currently worth $83 per share. Neither firm pays taxes.
Explanation / Answer
Value of equity = earnings / number of share outstanding
Unlevered = $29.3 million / 4.8 million
= $6.104
Levered = Earnings after interest / number of share outstanding
Earnings after tax = $29.3 million - (94 million * 8%) = $21.78 million
Value of equity = 21.78 / 2.6 million
= $ 8.38
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