Question

Kline Construction is an all-equity firm that has projected perpetual EBIT of $360,000. The current cost of equity is 13.3 percent and the tax rate is 40 percent. The company is in the process of issuing $976,000 worth of perpetual bonds with an annual coupon rate of 5.9 percent at par. What is the value of the levered firm

Answer 1

Answer:

Value of Levered Firm is 1,728,095

Explanation:

As company has total equity based, So, the cost of equity will be the discount rate to calculate the value of equity.

Value of Equity = $360,000 ( 1 - 0.4 ) / 13.3% = $1,624,060

Value of Debt = $976,000

Total value = $1,624,060 + $976,000 = $2,600,060

Now calculate the WACC

WACC = (13.3% x $1,624,060/$2,600,060) + (5.9% x $976,000/$2,600,060)

WACC = 8.3% + 2.2%

WACC = 10.5%

Now Assuming the EBIT remains the same.

Value of the firm = [ ( $360,000- (976,000 x 5.9%) ) x ( 1 - 0.4 ) ] / 10.5%

Value of the firm = $181,450 / 0.105 = 1,728,095