Question
Carnegie Ltd is an established company that expects its current earnings before interest and tax (EBIT) of $3,500,000 p.a. to be maintained indefinitely. The company
Carnegie Ltd is an established company that expects its current earnings before interest and tax (EBIT) of $3,500,000 p.a. to be maintained indefinitely. The company tax rate is 30%. IDK Ltd currently has no debt and its cost of equity is 14%.
Required:
a. What is the value of the firm? [2 marks]
b. The company is considering borrowing $15,000,000 and using the proceeds to repurchase shares. Assume it can borrow at an interest rate of 12% p.a. What will be the value of equity of the levered firm? [2 marks]
c. Several board members have raised concerns about the debt issuance. Briefly explain the agency costs between debtholders and equity holders. Your explanation should mention both the over-investment problem and the under-investment problem. [2 marks]
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