Folgers Air Transport (FAT) is currently an unlevered firm. It is considering a
ID: 2772011 • Letter: F
Question
Folgers Air Transport (FAT) is currently an unlevered firm. It is considering a capital restructuring to allow $200 in perpetual debt. The company expects to generate perpetual EBIT of $151.52. (Assume that depreciation equals capital expenditures and there are no additions to working capital.)
The corporate tax rate is 34% and the pre-tax cost of debt will be 10%. Unlevered firms in the same industry have a cost of equity capital of 20%.
Compute the value of FAT after the restructuring. Ignore any costs of financial distress and assume that interest tax shields are discounted at the pre-tax cost of debt.
Please show ALL work.
Explanation / Answer
Compute the value of FAT after restructuring.
Value of the firm = EBIT * (1 - tax rate) / cost of equity + Value of debt * tax rate
= $151.52 * (1 - 34%) / 0.20 + $200 * 34%
= $100 / 0.20 + $68
= $500 + $68
= $568.
Therefore, the value of the FAT after restructuring is $580.