Question 4

a) The market value of a firm that has $400,000 in debt is $1,000,000. The expected value of EBIT is a perpetuity. The interest rate on debt (pretax) is 10%. The company is subject to a 30% tax rate. If the company were 100% equity financed, the equity holders would have a 20% required return.

1. Calculate the market value of the firm if it were 100% equity financed.

(5 marks)

2. Calculate the company Earnings Before Interest and Tax (EBIT).

(6 marks)

3. Calculate net income of the company.

(2 marks)

b) Consider the following information for two all-equity firm AL and BL:

	Firm AL	Firm BL
Shares outstanding	2,000	6,000
Price per share	RM 40	RM 30

Firm AL estimates that the value of the synergistic benefit from acquiring Firm BL is RM 6,000. Firm BL indicated that it would accept cash purchase offer of RM 35 per share. Decide whether firm AL should proceed with the merger or not.