Hi I am having trouble with this question, i would like to know how to solve it
ID: 2772703 • Letter: H
Question
Hi I am having trouble with this question, i would like to know how to solve it though. Could you please show the steps and a little explanation. Thank you! and I will leave positive feedback!
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.
Explanation / Answer
Value of equity of unlevered firm = EBIT * (1 - tax rate) / cost of equity
= $151.52 * (1 - 34%) / 20%
= $500.02
After restructuring, WACC = [$500.02 * 20% + $200 * 10% * (1 - 34%)] / $700.02
= 16.17%
Value of firm after restructuring = [(EBIT - Interest) * (1 - tax rate) + Interest] / WACC
= [($151.52 - 10% * $200) * (1 - 34%) + 10% * $200] / 16.17%
= $660.50