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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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