In order to raise new equity Grimm Inc. employs Speed Bank. Grimm wants to raise
ID: 2718307 • Letter: I
Question
In order to raise new equity Grimm Inc. employs Speed Bank. Grimm wants to raise $28 million in equity for a new project (not including the fee paid to the investment bank). Grimm keeps a constant debt-to-value ratio equal to 40%. The required interest rate on debt is 4%. The expected return on levered equity is 8% The perpetual EBIT of the project is $5 million a year and there is no asset depreciation. The corporate tax rate is 36%. The NPV of the project is $3 million. What is the fee charged by the bank for issuing new equity (assume that there is no cost connected to debt issuance)? Show your working
Explanation / Answer
Grimm Inc. Details Amt $ Equity to be raised 28,000,000 Debt to value 40% Debt to equity 60% Debt amount 18,666,667 Total Investment 46,666,667 Cost of geared equity 8% Cast Of Debt 4% Tax rate 36% WACC =0.60*0.08+0.40*0.04(1-0.36) = 5.82% So WACC of project = 5.82% Interest per year on debt @4% 746,667 EBIT per annum 5,000,000 Lest Interest /annum (746,667) EBT /annum 4,253,333 Tax @ 36% 1,531,200 Profit after Tax & Cash flow per year for perpetuity 2,722,133 Present value of Cash flows =Net profit/WACC 46,772,050 NPV = 3,000,000 Let us assume to issuance cost of equity =k Total initial investment = Equity -Issuance cost+debt =46666667-k Now. 46772050-(46666667-k)=3000000 or. 105384+k =3000000 k= 2894616 So equity issuance cost is = $ 2,894,616