I am working on these study questions and am having trouble understanding how it all works...

50.1K

Verified Solution

Question

Finance

I am working on these study questions and am having troubleunderstanding how it all works together. Any help would be greatlyappreciated!!
An all equity firm is expected to generate perpetual EBIT of $50million per year forever. The corporate tax rate is 0% in a fantasyno tax world. The firm has an unlevered (asset or EV) Beta of 1.0.The risk-free rate is 5% and the market risk premium is 6%. Thenumber of outstanding shares is 10 million.

1. Calculate the existing WACC of this all equity or unleveredfirm. Calculate the total value of
this all equity firm and the existing share price.

2. The firm decides to replace part of the equity financing withperpetual debt. The firm issues
$100 million of permanent debt at the riskless interest rate of5%, and repurchases $100 million of equity.
A. Find the new value of the levered firm.
B. Find the new number of shares outstanding, and the new shareprice.

3. Calculate the new equity Beta, new cost of equity, and new WACCfollowing this capital
structure change. Assume a debt beta of zero.

Answer & Explanation Solved by verified expert

4.2 Ratings (594 Votes)

1 As the firm is all equity financed or unlevered the firms WACC will equal its unlevered cost of capital which in turn will equal its unlevered cost of equity as the only component of the capital structure is equity Asset Beta 1 RiskFree Rate 5 Market Risk Premium 6 Therefore Unlevered Cost of Equity Rf Unlevered beta See Answer

Get Answers to Unlimited Questions

Join us to gain access to millions of questions and expert answers. Enjoy exclusive benefits tailored just for you!

Membership Benefits:

Unlimited Question Access with detailed Answers
Zin AI - 3 Million Words
10 Dall-E 3 Images
20 Plot Generations
Conversation with Dialogue Memory
No Ads, Ever!
Access to Our Best AI Platform: Flex AI - Your personal assistant for all your inquiries!

Become a Member