Question
Mr. Schenk runs a franchise of laundry stores called Deep Clean Inc. (DCI). Currently DCI uses only equity capital. Mr. Schenk was approached by representatives
Mr. Schenk runs a franchise of laundry stores called Deep Clean Inc. (DCI). Currently DCI uses only equity capital. Mr. Schenk was approached by representatives from Lenders Inc. who have pointed out to him that his cost of unlevered equity capital is 15% and the cost of debt capital is only 6%. The reps said his company (which produces before-tax operating cash flows of $5 million per year) would benefit from using some debt. They recommend that he issues $12 million worth of bonds and use the entire proceeds to repurchase $12 million worth of its own stocks. Assume that both the firms cash flows and the debt are perpetual, and DCIs marginal corporate tax rate is 30%.
If Mr. Schenk follows Lenders Inc.s plan: i. What would be the value of the firm? Provide your answer in millions.
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