Colt Systems will have EBIT this coming year of $33 million. It will also spend
ID: 2754196 • Letter: C
Question
Colt Systems will have EBIT this coming year of $33 million. It will also spend $14 million on total capital expenditures and increases in the net working capital, and have $8 million in depreciation expenses. Colt is currently an all equity firm with a corporate tax rate of 30% and a cost of capital of 12%.
a. if Colt is expected to grow by 8.1% per year, what is the market value of its equity today?
b. If the interest rate on its debt is 10%, how much can colt borrow now and still have non-neg net income this comping year? c. Is there a tax incentive today for Colt to choose a debt to value ratio that exceeds 85%?
Explanation / Answer
value of firm = free cash flow(1+g)/ kc-g, where kc = ke= 12%, growth= 8.1%
free cash flows= EBIT(1-TAX) +depreciation- capex- working capital, It is assumed depeciation is already deducted from EBIT
=33(1-.30)+8-14= $17.1
VALUE OF FIRM= 17.1(1+.12) / .12-.081
=19.152/.0039
=$4910
=$11.5