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CASE_28_Instructor

# CASE_28_Instructor - This spreadsheet supports INSTRUCTOR...

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Please note: Revised: 7-Mar-06 Copyright © Darden Graduate Business School Foundation, Charlottesville VA. This spreadsheet supports INSTRUCTOR analysis of the case, "An Introduction to Debt Policy and Value" (Case 28). 1. Items shown in red in these worksheets are items to be calculated by the students 2. The calculations presented here are carried to the second decimal place to illustrate the exact accuracy of the calculations. The case sets up the problems in whole dollars. Some students may round to whole dollars; others may calculate to cents. Done consistently, the results in the first three problems will be the same, illustrating the key principle in this case.

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AN INTRODUCTION TO DEBT POLICY AND VALUE Many factors determine how much debt a firm takes on. Chief among them ought to be the effect of the debt on the value of the firm. Does borrowing create value? If so, for whom? If not, then why do so many executives concern themselves with leverage? If leverage affects value, then it should cause changes in either the discount rate of the firm (i.e., its weighted-average cost of capital) or the cash flows of the firm. 1. Please fill in the following: 0% Debt/ 25% Debt/ 50% Debt/ 100% Equity 75% Equity 50% Equity Book Value of Debt \$- \$2,500 \$5,000 Book Value of Equity \$10,000 \$7,500 \$5,000 Market Value of Debt \$- \$2,500 \$5,000 Market Value of Equity \$10,000 \$8,350 \$6,700 Pretax Cost of Debt 7.00% 7.00% 7.00% After-Tax Cost of Debt 4.62% 4.62% 4.62% Market Value Weights of Debt 0% 23% 43% Equity 100% 77% 57% Unlevered Beta 0.800 0.800 0.800 Levered Beta 0.800 0.958 1.194 Risk-Free Rate 7.00% 7.00% 7.00% Market Premium 8.60% 8.60% 8.60% Cost of Equity 13.88000% 15.23952% 17.26866% Weighted-Average Cost of Capital 13.88% 12.79% 11.86% EBIT \$2,103.00 \$2,103.00 \$2,103.00 Taxes (@ 34%) \$(715.02) \$(715.02) \$(715.02) EBIAT \$1,387.98 \$1,387.98 \$1,387.98 + Depreciation \$500.00 \$500.00 \$500.00 Capital Exp. \$(500.00) \$(500.00) \$(500.00) Free Cash Flow \$1,387.98 \$1,387.98 \$1,387.98 Value of Assets (FCF/WACC) \$9,999.86 \$10,849.84 \$11,699.83 Why does the value of assets change? Where, specifically, do the changes occur?
2. In finance, as in accounting, the two sides of the balance sheet must be equal. In the previous problem, we valued the asset side of the balance sheet.

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