Cavo Corporation expects an EBIT of $38,000 every year forever. The company curr

Question

Cavo Corporation expects an EBIT of $38,000 every year forever. The company currently has no debt, and its cost of equity is 13 percent. The corporate tax rate is 35 percent.

What is the current value of the company? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Suppose the company can borrow at 9 percent. What will the value of the company be if it takes on debt equal to 50 percent of its unlevered value? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Suppose the company can borrow at 9 percent. What will the value of the company be if it takes on debt equal to 100 percent of its unlevered value? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

What will the value of the company be if it takes on debt equal to 50 percent of its levered value? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

What will the value of the company be if it takes on debt equal to 100 percent of its levered value? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

$   

Cavo Corporation expects an EBIT of $38,000 every year forever. The company currently has no debt, and its cost of equity is 13 percent. The corporate tax rate is 35 percent.

Explanation / Answer

a
Current Value of company(unlevered)=38000*(1-35%)/13%=190000

b1
Value of Levered=Value of unlevered+tax rate*Debt=190000+50%*190000*35%=223250

b2
Value of Levered=Value of unlevered+tax rate*Debt=190000+100%*190000*35%=256500

c1

Value of levered=Value of unlevered+tax rate*Debt
=>value of levered=Value of unlevered+tax rate*50%*value of levered
=>value of levered=Value of unlevered+17.5%*value of levered
=>82.5%*value of levered=Value of unlevered
=>value of levered=Value of unlevered/82.5%
=>value of levered=190000/82.5%=230303

c2

Value of levered=Value of unlevered+tax rate*Debt
=>value of levered=Value of unlevered+tax rate*100%*value of levered
=>value of levered=Value of unlevered+35%*value of levered
=>65%*value of levered=Value of unlevered
=>value of levered=Value of unlevered/65%
=>value of levered=190000/65%=292307.7

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