Cavo Corporation expects an EBIT of $29,550 every year forever. The company curr

Question

Cavo Corporation expects an EBIT of $29,550 every year forever. The company currently has no debt, and its cost of equity is 11 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 7 percent. 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 and round your final answer to 2 decimal places. (e.g., 32.16))

Suppose the company can borrow at 7 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 50 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 $29,550 every year forever. The company currently has no debt, and its cost of equity is 11 percent. The corporate tax rate is 35 percent.

Explanation / Answer

a.

EBIT = $29,550

Earnings after taxes = $29,550 * (1-0.35) = $19,207.50

Current value of company = Earnings after taxes/Cost of equity = $19,207.50/0.11 = $174,613.64

b-1.

Value of firm = $174,613.64 + (0.50* $174,613.64 * 0.35) = $174,613.64 + $30,557.39 = $205,171.03

b-2.

Value of firm = $174,613.64 + (0.35 * $174,613.64) = $235,728.41

c-1.

With debt being 50 percent of the value of the levered firm,

Debt *0.35 * 0.50 = $174,613.64

Debt = $174,613.64 / 0.175 = $997,792.21

Value of company = $174,613.64 + (0.35* $997,792.21) = $523,840.91

c-2.

Debt * 0.35 = $174,613.64

Debt = $498,896.10

Value of company = $174,613.64 + ($498,896.10 * 0.35) = $349,227.28

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