For this and the next question (Assume earnings growth): 1. Aon Electronics has
ID: 2497800 • Letter: F
Question
For this and the next question (Assume earnings growth):
1. Aon Electronics has EBIT of $200,000, a growth rate of 6%, and a corporate tax rate of 40%. In order to support growth, Aon must reinvest 20% of its EBIT in its operating assets. The firm has $300,000 in 8% debt outstanding. A similar company with no debt has a cost of equity of 11% (i.e. rEU = 11%). According to the MM extension with growth, what is the value of Aon's interest tax savings?
a. $87,273
b. $120,000
c. $288,000
d. $192,000
e. $300,000
2. Refer to above. According to the MM extension with growth, what is the unlevered value of the firm? [To help you correctly answer this question, please note that FCF = $80,000]
a. $1,090,909
b. $1,792,000
c. $2,400,000
d. $4,000,000
e. $1,600,000
Explanation / Answer
1)
value of Aon's interest tax savings = Debt*tax rate
value of Aon's interest tax savings = 300000*40%
value of Aon's interest tax savings = 120000
Answer
b) 120000
2)
FCFF = NOPAT-Capital Expenditure
FCFF = 200000*(1-40%) - 20%*200000
FCFF = 80000
Unlevered value of the firm = FCFF/(Unlevered Cost of Equity-growth rate)
Unlevered value of the firm = 80000/(11%-6%)
Unlevered value of the firm = $ 1600000
Answer
e. $1,600,000