Question
NEED HELP WITH LAST PART (Number 3) 1. MacKinnon Co. currently has EBIT of $45,000 and is all equity financed. EBIT is expected to stay
NEED HELP WITH LAST PART (Number 3)
1. MacKinnon Co. currently has EBIT of $45,000 and is all equity financed. EBIT is expected to stay at this level indefinitely. The firm pays corporate taxes equal to 29% of taxable income. The cost of equity for this firm is 16%.
What is the market value of the firm? ANS: 199,687.5
2. Suppose the firm has a value of $199,687.5 when it is all equity financed. Now assume the firm issues $51,000 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: 214,477.5
What will be the value of the equity after the debt issue? ANS: 163,477.5
3. Suppose that with the $51,000 of debt and no costs to financial distress the firm has a value of $214,477.5. Suppose, in addition:
- The debt issue raises the possibility of bankruptcy.
- The firm has a 20% chance of going bankrupt after 2 years.
- If it goes bankrupt, it will incur bankruptcy costs of 50,000.
- The discount rate is 16%.
What is the value of the firm?
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