XZY Inc an all-equity firm where annual sales are expected to be $100 million in
ID: 2802308 • Letter: X
Question
XZY Inc an all-equity firm where annual sales are expected to be $100 million in perpetuity. The firm estimates its cost of production will be 65% of sales. The stock’s beta is currently 1.30 and faces a 30% tax rate. Further, there are 5 million shares outstanding. The current yield-to-maturity on T-Bills is 2.7%, and the market risk premium is 7%. The firm is considering buying back $50 million of equity by issuing debt. The firm can issue debt at 8%. Post recapitalization, what is the value of:
1. The firm
2. The firm’s equity? **** SHOW ALL WORKING AND STEPS*****
Explanation / Answer
Re = 2.7% + 1.3*7% = 11.8%
PAT = 100*(1-65%)*(1-30%) = 24.5 million
Equity value = 24.5 / 11.8% = 207.6271
Recapitalization
Wd = 50 / (50 + 207.6271) = 0.1941
We = 1 - 0.1941 = 0.8059
WACC = 0.1941*8%*(1-30%) + 0.8059*11.8% = 10.5966%
Firm value = 24.5 / 10.5966% = 231.2067
Equity = 231.2067 - 50 = 181.2067
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