Question

Milton Industries expects free cash flows of $14 million each year. Milton's corporate tax rate is 21%, and its unlevered cost of capital is 15%. Milton also has outstanding debt of $23.44 million, and it expects to maintain this level of debt permanently. a) What is the value of Milton Industries without leverage? b) What is the value of Milton Industries with leverage?

Answer 1

Answer:

(A) $93.33 million

(B) $98.25 million

Explanation:

Milton expects a free cash flow of $14 million each year

The corporate tax rate is 21%

The unlevered cost of capital is 15%

Milton has an outstanding debt of $23.44 million.

(A) The value of Milton's industry without leverage can be calculated as follows

= Free cash flow/unlevered cost of capital

= $14 million/15%

= $14 million/0.15

= $93.33 million

(B) The value of Milton with leverage can be calculated as follows

= unlevered value + tax rate × debt

= $93.33 million + 21% × $23.44 million

= $93.33 million + 0.21 × $23.44 million

= $93.33 million + $4.922 million

= $98.25 million