Folgers Air Transport (FAT) is currently an unlevered firm. It is considering a
ID: 2772020 • 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
value of unlevered firm = EBIT (1-t)/ke
= $151.52(1- 0.34) /0.2
= 500.016
value of levered firm = value of unlevered firm+ debt (tax rate)
= 500.016 + ($200 *10%)
=$520.
=