Question 6:

Keystone Corporation most recent EBIT was $50,000; it is expected to grow at 2% per year forever. The company currently has no debt, and its cost of equity is 10%. The corporate tax rate is 30%. For simplicity, suppose that there will not be adjustments in capital spending and net working capital going forward.

(a) What is current value of the company?

(b) What will the value of the firm be if the company takes on debt equal to 40% of its unlevered value? Ignore any default considerations.

(c) How will your result of part (b) changes if the firm takes on debt equal to 40% of its levered value?

(d) What is firms WACC in parts (a), (b) and (c)? Briefly comment on the differences.