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fm16 6 - 348 3 $ 0896 40 1 000 500($ WACC T 1 EBIT WACC FCF...

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Answers and Solutions: 16 - 6 16-9 a. Original value of the firm (D = $0): We are given that the book value of asset is equal to the market value of assets, so the value is $3,000,000. Alternatively, we can calculate the value as the sum of the debt (which is zero) and the stock (200,000 shares at a price of $15 per share): V = D + S = 0 + ($15)(200,000) = $3,000,000. Original cost of capital: WACC = w d r d (1-T) + w ce r s = 0 + (1.0)(10%) = 10%. With financial leverage (w d =30%): WACC = w d r d (1-T) + w ce r s = (0.3)(7%)(1-0.40) + (0.7)(11%) = 8.96%. Because growth is zero, FCF is equal to EBIT(1-T). The value of operations is: V op = . 286 . 214 ,
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Unformatted text preview: 348 , 3 $ 0896 . ) 40 . 1 )( 000 , 500 ($ WACC ) T 1 )( EBIT ( WACC FCF = − = − = Increasing the financial leverage by adding $900,000 of debt results in an increase in the firm’s value from $3,000,000 to $3,348,214.286. b. Using its target capital structure of 30% debt, the company must have debt of: D = w d V = 0.30($3,348,214.286) = $1,004,464.286. Therefore, its value of equity is: S = V – D = $2,343,750. Alternatively, S = (1-w d )V = 0.7($3,348,214.286) = $2,343,750. The new price per share, P, is: P = [S + (D – D )]/n = [$2,343,750 + ($1,004,464.286 – 0)]/200,000 = $16.741....
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