Letang Corporation expects an EBIT of $23,750 every year forever. The company cu

Question

Letang Corporation expects an EBIT of $23,750 every year forever. The company currently has no debt, and its cost of equity is 16 percent. The company can borrow at 9.5 percent and the corporate tax rate is 35. (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)

Requirement 1: What is the current value of the company?    

(a) What will the value of the firm be if the company takes on debt equal to 60 percent of its unlevered value?

(b) What will the value of the firm be if the company takes on debt equal to 100 percent of its unlevered value

(a) What will the value of the firm be if the company takes on debt equal to 60 percent of its levered value?

b) What will the value of the firm be if the company takes on debt equal to 100 percent of its levered value?

Requirement 2:

(a) What will the value of the firm be if the company takes on debt equal to 60 percent of its unlevered value?

(b) What will the value of the firm be if the company takes on debt equal to 100 percent of its unlevered value

Requirement 3:

(a) What will the value of the firm be if the company takes on debt equal to 60 percent of its levered value?

b) What will the value of the firm be if the company takes on debt equal to 100 percent of its levered value?

Explanation / Answer

Letang Corporation: EBIT of $23,750 cost of equity is 16 percent.

Cost of Debt before tax 9.5 percent : Corporate tax rate is 35 % : Post tax Cost if debt = 9.5 (1-0.35) = 6.175%

Requirement 1: Value of the Firm = Value of Equity + Value of debt

Since there is no debt for the firm , Value of debt is equalt to 0

Value of Equity = EBIT (1-T)/Ke = $23750(1-0.35)/16% =$ 96484.38

So Value of the Frm = $ 96484.38

Requirement 2:

If a company takes 60 % of the unlevered value as the Debt , then

Vaue of debt = 96484.38 * 60 % = 57890.625

Then Value of the Firm = Value of Debt + Value of Equity

Particluars Amt( $ ) EBIT $23,750.00 Less: Interest $5,499.61 EBT $18,250.39 Less: Tax @ 35%% $6,387.64 EAT $11,862.75 Cost of Equity (Ke) 16% Market value of Equity $74,142.21 Cost of Debt (Kd) 6.175% Market value of Debt $89,062.50 Market value of the Firm $1,63,204.71

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