Question

From the next year onwards, Colt Systems is estimated to have an EBIT of $15 million. It will also spend $6 million annually on total capital expenditures and increases in net working capital, and have $3 million in depreciation expenses. Colt is currently an all-equity firm with a corporate tax rate of 35% and a cost of capital of 10%. a) What is the market value of its equity today (assuming all cash flows are paid back to the equity holders at the end of each year)?

Answer 1

Answer: $67.5 million

Explanation:

Since we are given the information that all cash flows are paid back to the equity holders at the end of each year, the market value of its equity today will be:

= [EBIT × (1 - t) + Depreciation - Capital Expenditure - Change in Working capital] / (Cost of Capital - Growth rate)

= ($15 million(1 - 35%) + $3 million - $6 million) / 10%

= [$15 million (1 - 0.35) + $3 million - $6 million] / (10%

= ($15 million × 0.65) + $3 million - $6 million) / 0.1

= ($9.75 million + $3 million - $6 million)/0.1

= $6.75 million / 0.1

= $67.5 million