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Valuing a Levered Firm
A company has a debt-to-equity ratio of 0.55. The required return on the company's unlevered equity is 15 percent, and the pre-tax cost of the firm's debt is 8 percent. Sales revenue for the company is expected to remain stable indefinitely at last year's level of $23,200,000. Variable costs amount to 75 percent of sales. The tax rate is 35 percent, and the company distributes all its earnings as dividends at the end of each year.
1. If the company were financed entirely by equity, how much would it be worth?
2. What is the required return on the firm's levered equity (assume no bankruptcy costs)?
3. Use the WACC method to calculate the value of the company. What is the value of the company's equity? What is the value of the company's debt?
4. Use the FTE method to calculate the value of the company's equity.
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