10 7. The new employee in investment analyst wants to evaluate the effect of value of firm from the capital structure. For the simplicity, he assumes that there is no transaction cost and issuance cost associated with security trading. The cost of capital for the unlevered firm is constant. The basis of evaluating the value of the firm is an earning before interest and tax (EBIT) and the corporate tax rate, which are perpetually constant. In addition, the distribution of the return of in- vestment is applied perpetually to both debt holders and shareholders. Finally, the return of the shareholder is based on the dividend and the retained earnings. Currently, the company which he wants to evaluate has the EBIT worth $60 million. The cost of unlevered firm (or the cost of asset) is 15% and the corporate rate tax rate is 25%. (a) [4 points] Suppose the company issues the debt with $175 million. Calculate the value of the levered firm. (b) [6 points) When the company uses $175 million issuing the debt (which is coming from the previous question), the cost of debt is applied with 8%. Calculate the cost of the levered equity. Then calculate the weighted average cost of capital. (e) [3 points) For more complicated scenario, the analyst should also reflect on the financial distress cost, the agency cost, and the agency benefit. Especially, the present value of the agency benefit is the incremental factor of the value of the firm using the leverage. List two possible benefits for the company, including the manager, when the leverage increases. 10 7. The new employee in investment analyst wants to evaluate the effect of value of firm from the capital structure. For the simplicity, he assumes that there is no transaction cost and issuance cost associated with security trading. The cost of capital for the unlevered firm is constant. The basis of evaluating the value of the firm is an earning before interest and tax (EBIT) and the corporate tax rate, which are perpetually constant. In addition, the distribution of the return of in- vestment is applied perpetually to both debt holders and shareholders. Finally, the return of the shareholder is based on the dividend and the retained earnings. Currently, the company which he wants to evaluate has the EBIT worth $60 million. The cost of unlevered firm (or the cost of asset) is 15% and the corporate rate tax rate is 25%. (a) [4 points] Suppose the company issues the debt with $175 million. Calculate the value of the levered firm. (b) [6 points) When the company uses $175 million issuing the debt (which is coming from the previous question), the cost of debt is applied with 8%. Calculate the cost of the levered equity. Then calculate the weighted average cost of capital. (e) [3 points) For more complicated scenario, the analyst should also reflect on the financial distress cost, the agency cost, and the agency benefit. Especially, the present value of the agency benefit is the incremental factor of the value of the firm using the leverage. List two possible benefits for the company, including the manager, when the leverage increases