Question
Alias Industries is currently an all-equity firm. In the coming year the firm is forecasting annual EBIT level $580,000 . The firm expects no growth
Alias Industries is currently an all-equity firm. In the coming year the firm is forecasting annual EBIT level $580,000. The firm expects no growth in the EBITs as it will pay all the earnings in cash dividends to its shareholders. As a result, the EBIT level of $580,000 will remain constant forever. The asset beta of the firm has an estimated value of 1.25. The expected return on a Government of Canada treasury bill is 2.2%, and the return on the TSX composite index is 7.6%. The firm has 260,000 shares of common stock outstanding.
M&M Case II: Assume tax rate is 35% but no default risk. Assume before tax cost of debt is 2.2%.
d) What is the WACC of this all-equity financed firm? What is the value of the firm? (2 marks)
e) What would be the firms value and overall cost of capital, if the firm uses $2,400,000 (market value) debt in generating its EBITs of $580,000? (4 marks)
f) Complete the following table. In M&M case II, what level of debt is optimal? (1mark)
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Value of Firm | Value of Debt | Value of Equity | RD | RE | WACC |
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?? | 0 | ?? | 2.2% | ?? | ?? |
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4,422,291 | 600,000 | 3,822,291 | 2.2% | 9.639% | 8.525% |
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4,632,291 | 1,200,000 | 3,432,291 | 2.2% | 10.484% | 8.139% |
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4,842,291 | 1,800,000 | 3,042,291 | 2.2% | 11.546% | 7.786% |
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?? | 2,400,000 | ?? | 2.2% | ?? | ?? |
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5,262,291 | 3,000,000 | 2,262,291 | 2.2% | 14.768% | 7.164% |
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5,472,291 | 3,600,000 | 1,872,291 | 2.2% | 17.386% | 6.889% |
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