Mojito Mint Company has a debt–equity ratio of .25. The required return on the c

Question

Mojito Mint Company has a debt–equity ratio of .25. The required return on the company’s unlevered equity is 15 percent, and the pretax cost of the firm’s debt is 7.4 percent. Sales revenue for the company is expected to remain stable indefinitely at last year’s level of $17,900,000. Variable costs amount to 65 percent of sales. The tax rate is 35 percent, and the company distributes all its earnings as dividends at the end of each year. a. If the company were financed entirely by equity, how much would it be worth? (Enter your answer in dollars, not millions of dollars, i.e. 1,234,567. Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16)) Value of the company $ b. What is the required return on the firm’s levered equity? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16)) Required return % c-1. Use the weighted average cost of capital method to calculate the value of the company. (Enter your answer in dollars, not millions of dollars, i.e. 1,234,567. Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16)) Value of the company $ c-2. What is the value of the company’s equity? (Enter your answer in dollars, not millions of dollars, i.e. 1,234,567. Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16)) Value of equity $ c-3. What is the value of the company’s debt? (Enter your answer in dollars, not millions of dollars, i.e. 1,234,567. Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16)) Value of debt $ d. Use the flow to equity method to calculate the value of the company’s equity. (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16)) Value of equity $

Explanation / Answer

(a) Computation of the worth of company if the company were financed entirely by equity.We have,

(b) Computation of the required return on the firm’s levered equity.We have,

Required return on leavered equity = Return on unleavered equity + Debt/ equity[ Return on unleavered equity - Cost of debt] (1 - tax rate)

Required return on leavered equity = 15 + 0.25(15 - 7.4)(1- 0.35)

Required return on leavered equity = 15 + 1.24 = 16.24%

Hence, the required return on leavered equity is 16.24%

(c-1) Computation of the value of company by using the weighted average cost of capital method.We have,

Debt/Equity ratio = 0.25

debt = 0.25

equity = 1.00

Total capital = 1.25

WACC = Re x Equity/ Total capital + Rd x Debt/ total capital (1-tax rate)

WACC = 15 X (1.00/1.25) + 7.4(0.25/1.25)(1 - 0.35)

WACC = 12 + 0.96 = 12.96%

Step2: Computaiton of the value of company.We have,

Value of company = Earning for equityholder / WACC

Value of company = 4,072,250/12.96% = $ 31,421,682.10

Hence, the value of company is $ 31,421,682.10

(c-2) Computation of the value of the company's equity.We have,

Toal value of company = $ 31,421,682.10

proportion of equity = 31,421,682.10 x 1.00/1.25 = $ 25,137,345.68

Hence, the value of company's equity is $ 25,137,345.68

(c-3) Computation of the value of debt.We have,

Total value of company = $ 31,421,682.10

proportion of debt = 31,421,682.10 x 0.25/1.25 = $ 6,284,336.42

Hence, the value of company's debt is $ 6,284,336.42

(d) Computation of the value of equity using the flow to equity method.We have,

Particulars Amount($) Sales 17,900,000 Less: Contribution 17,900,000 x0.65 11,635,000 EBIT 6,265,000 Less: tax@35% 6,265,000 x 0.35 2,192,750 Earning for equity 4,072,250 Required return for equity 15% Value of company 4,072,250/15% $ 27,148,333

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