Question
Casada Travel Adventures has a total market value of $120 million, consisting of 1 million shares selling for $60 per share and $60 million of
Casada Travel Adventures has a total market value of $120 million, consisting of 1 million shares selling for $60 per share and $60 million of 5% perpetual bonds now selling at par. The companys EBIT is $30 million, and its tax rate is 25%. Casada can change its capital structure by either increasing its debt to 60% or decreasing it to 40%. If it decides to increase its use of leverage, it must call its old bonds and replace them with new ones with a 6% coupon. If it decides to decrease its leverage, it will call its old bonds and replace them with new 4% coupon bonds. The company will sell or repurchase stock at the new equilibrium price to complete the capital structure change. The firm pays out all earnings in dividends; hence, its stock is a zero-growth stock. Its current cost of equity is 10%. If it increases leverage, the cost of equity will be 12%. If it decreases leverage, the cost of equity will be 8%. What is the total corporate value if Casada increases its leverage?
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