Question
Colt Systems will have EBIT this coming year of $ 16 million. It will also spend $ 4 million on total capital expenditures and increases
Colt Systems will have EBIT this coming year of
$ 16
million. It will also spend
$ 4
million on total capital expenditures and increases in net working capital, and have
$ 2
million in depreciation expenses. Colt is currently an all-equity firm with a corporate tax rate of
30 %
and a cost of capital of
12 %
.
a. If Colt's free cash flows are expected to grow by
10.3 %
per year, what is the market value of its equity today?
b. If the interest rate on its debt is
10 %
,
how much can Colt borrow now and still have non-negative net income this coming year?
c. Is there a tax incentive today for Colt to choose a debt-to-value ratio that exceeds
40 %
?
Explain.
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