Reference no: EM132975832

Question - Assume that a company is expected to produce EBIT of $150M in perpetuity. The corporate tax rate the company is subject to is 21%. To maintain the existing production capacities and support sales growth, capital expenditures are expected to be at $40M per year, in perpetuity. Annual depreciation, expected in perpetuity as well, is $30M. The current risk- free rate is 2%, and it is expected to remain so in perpetuity. The company has $120M in long- term debt, which is considered by the bank to be risk-free, so the interest rate the firm pays on its debt is 2%. The company expects to hold that amount of debt in perpetuity. Using stock returns on a comparable company that operates in the same industry, and has debt outstanding equal to 50% of the market value of its total capital, analysts estimated that the comparable company's beta is 1.2. The analysts believe the companies are comparable in all respects except for the capital structure, and do not expect that beta to change over time. You also know that the estimate of the market risk premium for the foreseeable future is 5%. The firm has 10M common shares outstanding.

a) Please calculate the value of the firm. You can use the Adjusted Present Value methodology, calculating the value of unlevered firm, and then adding the value of the tax shield due to debt. The assumption is that the costs of financial distress are zero, because debt is risk-free and the probability of default is zero.

b) Please calculate the value of the firm's equity. Assume that the firm decided to issue additional debt in the amount of $100M. Also assume that the risk of the firm's debt would not change due to the issuance of new debt.

c) What do you expect the value of the firm's equity to be if the company were to issue new debt and use the proceeds from this debt issue to repurchase equity?

d) What price per share would the firm repurchase the equity at?