Question
Peete Simmer plans to maintain its target leverage of 0.25 (i.e., D/V), with debt that pays 7% interest. Although Peetes equity does not trade publicly,
Peete Simmer plans to maintain its target leverage of 0.25 (i.e., D/V), with debt that pays 7% interest. Although Peetes equity does not trade publicly, its main competitor is publicly traded. Assume Peete and its main competitor have the same overall business risk. This competing firm is 40% debt financed, with costs of equity and debt at 17% and 9%, respectively. The corporate tax rate is 40%.
Peete Simmer is now considering an alternative financing structure for the firm. Instead of maintaining a debt ratio of 25%, they are considering issuing $6M in debt at 8% interest. This would then be Peetes only debt. The company would pay down $0.25M per year until the balance reaches $5M, and maintain this balance thereafter. Assume interest tax shields are as risky as the debt.
e) (6 pts) What is the value of Peete under this alternative financing structure? (Use APV)
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