Question
MacKinnon Co. currently has EBIT of $48,000 and is all equity financed. EBIT is expected to stay at this level indefinitely. The firm pays corporate
MacKinnon Co. currently has EBIT of $48,000 and is all equity financed. EBIT is expected to stay at this level indefinitely. The firm pays corporate taxes equal to 37% of taxable income. The cost of equity for this firm is 14%.
What is the market value of the firm?
Ans: 216,000
Suppose the firm has a value of $216,000 when it is all equity financed. Now assume the firm issues $52,000 of debt paying interest of 8% per year and uses the proceeds to retire equity. The debt is expected to be permanent.
What will be the value of the firm?
Ans: 235,240
What will be the value of the equity after the debt issue?
Ans: 183,240
Suppose that with the $52,000of debtthe firm has a value of $235,240 and a value of equity of $183,240.What will be the expected rate of return on the equity?
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