Colt Systems will have EBIT this coming year of $ 29 million. It will also spend
ID: 2798322 • Letter: C
Question
Colt Systems will have EBIT this coming year of $ 29 million. It will also spend $ 14 million on total capital expenditures and increases in net working capital, and have $ 8 million in depreciation expenses. Colt is currently an all-equity firm with a corporate tax rate of 38 % and a cost of capital of 10 % . a. If Colt's free cash flows are expected to grow by 6.7 % per year, what is the market value of its equity today? b. If the interest rate on its debt is 8 % , how much can Colt borrow now and still have non-negative net income this coming year? c. Is there a tax incentive today for Colt to choose a debt-to-value ratio that exceeds 110 % ? Explain.
Explanation / Answer
a) Market Value of Equity
= EBIT*(1-T) + D - CE -Change in NWC
T- Tax rate, D- Depreciation , CE- Capital Expenditure, NWC- Networking Capital
= 29*(1-0.38)+8-4
= 11.98
= (11.98/(10%-6.7%))*100= 353.939 million
B) Interest Expense = (EBIT/ Interest Rate) *100 = (29/0.08) =362.5 million
C) No. The maximum amount that colt systems can borrow is 362.5 million; there is no interest tax incentive from borrowing more.