AAA Inc. is a levered firm, and ZZZ Inc. is an unlevered firm. They are exactly the same in every possible way, however they hav

Question

3 years ago

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AAA Inc. is a levered firm, and ZZZ Inc. is an unlevered firm. They are exactly the same in every possible way, however they hav

e different capital structures. AAA Inc. and ZZZ Inc. each expect to generate $11.1 million in earnings before interest and taxes, every year, in perpetuity. Both AAA Inc. and ZZZ Inc. do not retain any net income and distribute all of it as dividends to their stockholders. Levered AAA Inc. has debt with neverending interest payments which has the current market value of $59 million and has an annual interest rate of 5 percent. Also, AAA Inc. has 1.7 million shares outstanding, and each share sells for $75 in the market. Unlevered ZZZ Inc. has no debt, 3.4 million shares outstanding, and each share goes for $58 in today's market. Both AAA Inc. and ZZZ Inc. do not pay taxes on their income.
Required:
Calculate the equity value of each company.

Business

1 answer:

Ostrovityanka [42] · Answer 1 · 2022-06-03T17:39:50+03:00

Answer:

AAA Inc. and ZZZ Inc.

AAA Inc ZZZ Inc.

Equity value = $127.5 million $197.2 million

Explanation:

a) Data and Calculations:

AAA Inc ZZZ Inc.

Annual earnings before interest and taxes $11.1 million $11.1 million

Annual interest (5% of $59 million) $2.95 million

Income taxes $0 $0

Annual dividends payments $8.15 million $11.1 million

Annual retained earnings $0 $0

Current market value of debts $59 million $0

Outstanding shares 1.7 million 3.4 million

Market price per share $75 $58

Equity value = (outstanding shares * market price)

= $127.5 million $197.2 million

(1.7 million * $75) (3.4 million * $58)

Total assets $186.5 million $197.2 million