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Lion Corp is an all equity firm. The firm's annual EBIT is currently $10 million and is expected to remain at that level indefinitely. The current expected return on Lion's stock is 20% and the firm pays corporate tax at the 35% rate. (a) Calculate the current value of Lion Corp. as an unlevered firm. (b) Suppose that Lion sells $10 million in debt and repurchases $10 million in equity. The debt they issue will offer a 10% interest rate. Once Lion undertakes this action, they intend to keep this level of debt financing for the foreseeable future. What will be the total market value of Lion Corp. (debt plus equity) after this change in financial structure is complete? (c) If Lion takes the actions outlined in part (b), what will be the expected return on the firm’s stock after the change in capital structure? (d) If Lion takes the actions outlined in part (b), what will be the firm’s weighted average cost of capital after the change in capital structure?
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