Question
ABC Ltd has no debt and is currently valued at $500 million. The company is considering a permanent increase in debt of $60 million. Suppose
ABC Ltd has no debt and is currently valued at $500 million.
The company is considering a permanent increase in debt of $60 million.
Suppose the tax rate is 30%, the weighted average cost of capital is 12% and the cost of debt is 4%.
Required:
(a) Estimate the company's value with the nw leverage.
(B) ABC Ltd believe that if it permanently increase its level of debt, the risk of financial distress may cause it to lose some customers and receive less favourable terms from its suppliers. As a result, the company's expected free cash flows with debt will be decreased by $6 million each year forever.
Estimates the company's value with the new leverage, incorporating the effects of financial distress.
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