Question 6 (of 6) Save & ExtSubmit value: 10.00 points Mojito Mint Company has a

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Question 6 (of 6) Save & ExtSubmit value: 10.00 points Mojito Mint Company has a debt-equity ratio of .35. The required return on the company's unlevered equity is 11 percent, and the pretax cost of the firm's debt is 8.8 percent Sales revenue for the company is expected to remain stable indefinitely at last year's level of $19,300,000. Variable costs amount to 70 percent of sales. The tax rate is 35 percent, and the company distributes all its eamings as dividends at the end of each year If the company were financed entirely by equity, how much would it be worth? (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) a. Value of the company b. What is the required return on the firm's levered equity? (Do not round intermediate calculations and enter your answer as a percent rounded 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, e.g., 1,234,567. Do not round intermediate calculations and round your 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, e.g., 1,234,567. Do not round intermediate calculations and round your 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, e.g., 1,234,567. Do not round intermediate calculations and round your 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. (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567, Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Value of equity

Explanation / Answer

a) If Mojito were financed entirely by equity, the value of the firm would be equal to the present value of its unlevered after-tax earnings, discounted at its unlevered cost of capital of 11%.
Sales = 19,300,000
Variable Costs = 0.7*19,300,000 = 13,510,000
EBIT = 19,300,000 - 13,510,000 = 5,790,000
Taxes (@35%) = 2,026,500
PBT = 3,763,500
VU = 3,763,500/0.11 = 34,213,636.36

b) According to Modigliani-Miller Proposition II with corporate taxes:
rS = r0 + (B/S)(r0 – rB)(1 – TC)
where     r0 = the required return on the equity of an unlevered firm
rS = the required return on the equity of a levered firm
rB = the pre-tax cost of debt
TC = the corporate tax rate
B/S = the firm’s debt-to-equity ratio

In this problem: r0 = 0.11, rB = 0.088,TC = 0.40, B/S = 0.35
The required return on Mojito’s levered equity is:rS = 0.11 + (0.35)(0.11 – 0.088)(1 – 0.35) = 0.115005
The required return on Mojito’s levered equity (rS) is 11.5%.

c1) rwacc = {B / (B+S)}(1 – TC) rB + {S / (B+S)}rS
rwacc = {0.35/(1.35)}*(1 – 0.35)*0.088 + {1/(1.35)}*0.11 = 0.0963 = 9.63%

c2) VL = 3,763,500/0.0963 = 39,080,996.89
Value of Equity = 39,080,996.89*1/1.35 = 28,948,886.58

c3) Value of Debt = 39,080,996.89 - 28,948,886.58 = 10,132,110.31

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