Answered step by step
Verified Expert Solution
Question
1 Approved Answer
Un-Levered Co. and Levered Co, are two identical companies in all aspects except for their capital structures. Un-Levered Co. is an all-equity financed company, with
Un-Levered Co. and Levered Co, are two identical companies in all aspects except for their capital structures. Un-Levered Co. is an all-equity financed company, with total market value $600,000. Lever Co. uses both stock and perpetual debt; Yield-to-maturity of the debt is 9% and coupon payments in each period is $18,000. Both companies generate EBIT of $75,000. Assume no taxes, and lending rate = borrowing rate. la) What are the market values of Levered Co.'s debt and equity (4%)? What is the debt-to-equity ratio of Levered Co. (1%)? An investor can generate exactly the same cash flows and ROE as holding $45,000 of Un- Levered Co.'s stocks by lending money at interest rate of 9% and investing in the Levered Co.'s stocks (i.c. homemade un-leverage). 1b) What is the ROE of Un-Levered Co. (1%)? How much should the investor lend out and invest in Leveled Co. stocks (2%)? Demonstrate how the investor can generate the same cash flows and ROE as holding Un-Levered Co.'s stocks (5%). Now suppose that there is tax rate of 30% and Un-Lever Co. has 10,000 shares outstanding. Further assume that the company wants to increase level by issuing the 9% yield perpetual debt with coupon payments $18,000 in each period, and uses the money to buy back some existing shares. The company still generates EBIT $75,000. le) What are the market values of the debt and equity of Un-levered Co. after issuance of the debt (6%)? What is the final share price (2%)? How many outstanding shares remain (2%)? (Assume the company can buy back non-integer numbers of shares. Other things being equal, it is good for a company to borrow money, and why (2%)
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started