Question 2

Griffin Doors earns $1 million in annual EBIT in perpetuity on its $5million in assets.After making repairs to assets to exactly offset depreciation, all earnings are paid out as dividends.The firm is entirely owner financed (no debt) so its cost of capital is its cost of equity, which is 10%.The corporate tax rate is 30%.

a)How much is Griffin Doors worth to its owners? (3 marks)

b)If the company borrows $1 million and uses that money to buy back shares from the owners, how will this affect the value of the firm?Be specific (3 marks)

c)What will the company's WACC be after the it borrows the money? (2 marks)

d)Why do most small businesses operate with less leverage than Miller and Modigliani's model would consider to be optimal? (2 marks)