Cavo Corporation expects an EBIT of $18,100 every year forever. The company curr

Question

Cavo Corporation expects an EBIT of $18,100 every year forever. The company currently has no debt, and its cost of equity is 16 percent. The corporate tax rate is 35 percent.

What is the current value of the company? (Round your answer to 2 decimal places. (e.g., 32.16))

Suppose the company can borrow at 11 percent. What will the value of the firm be if the company takes on debt equal to 40 percent of its unlevered value? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

Suppose the company can borrow at 11 percent. 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 and round your final answer to 2 decimal places. (e.g., 32.16))

What will the value of the firm be if the company takes on debt equal to 40 percent of its levered value?(Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))

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 and round your final answer to 2 decimal places. (e.g., 32.16))

Cavo Corporation expects an EBIT of $18,100 every year forever. The company currently has no debt, and its cost of equity is 16 percent. The corporate tax rate is 35 percent.

Explanation / Answer

Part a)

The current value of the company can be calculated as follows:

Current Value (Value of Unlevered Firm) = EBIT*(1-Tax Rate)/Cost of Equity

Using the values provided in the question, we get,

Current Value (Value of Unlevered Firm) = 18,100*(1-35%)/16% = $73,531.25

________

Part b-1)

The value of the firm with debt can be calculated as follows:

Value of the Firm = Value of Unlevered Firm + Tax Rate*(Value of Unlevered Firm*Debt Percentage)

Susbstituting the relevant values in the above formula, we get,

Value of the Firm = 73,531.25 + 35%*(73,531.25*40%) = $83,825.63

________

Part b-2)

The levered value of the firm can be calcuated as follows:

Levered Value = Value of Unlevered Firm + Tax Rate*(Value of Unlevered Firm*Debt Percentage)

Susbstituting the relevant values in the above formula, we get,

Levered Value = 73,531.25 + 35%*(73,531.25*100%) = $99,267.19

________

Part c-1)

Let us say that value of the levered firm is X. The value of the firm is derived with the use of following formula:

Value of the Firm = Value of Unlevered Firm + Tax Rate*(Value of Levered Firm*Debt Percentage)

Susbstituting the relevant values in the above formula, we get,

X = 73,531.25 + 35%*(X*40%)

Rearranging Values, we get,

X (Value of the Firm) = 73,531.25/(1-.14) = $85,501.45

________

Part c-2)

Let us say that value of the levered firm is X. The levered value of the firm can be calcuated as follows:

Levered Value = Value of Unlevered Firm + Tax Rate*(Value of Unlevered Firm*Debt Percentage)

Susbstituting the relevant values in the above formula, we get,

X = 73,531.25 + 35%*(X*100%)

Rearranging Values, we get,

X (Levered Value) = 73,531.25/(1-.35) = $113,125

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