Ice Cream Sandwich Co. expects EBIT of $300,000 every year forever. Ice Cream Sandwich Co. currently...

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Finance

Ice Cream Sandwich Co. expects EBIT of $300,000 every yearforever. Ice Cream Sandwich Co. currently has no debt and its costof equity is 20%. The firm can borrow at 5%. The corporate tax rateis 33%. The value of the firm is 1005000.
Questions:
a. what will be the value of the firm if Ice Cream Sandwich Co.borrows $280,000 of permanent debt and uses the proceeds to buyback stock?
b. how can Ice Cream Sandwich Co. maximize the value of thefirm? What will be the maximum value if there are no costs tofinancial distress?
c. Suppose that with $280,000 of debt, there is a 13%probability of financial distress, in which case the firm will havea present value of $220,000. What is the value of the firm in thiscase? Recall that the value of the firm with $280,000 debt and nocosts to financial distress was $1,097,400.
Answer for a. 1097400. b. 1500000 c. 983338. How can I get thoseanswers? Please write in detail calculation, dont use theexcel.

Answer & Explanation Solved by verified expert

4.1 Ratings (484 Votes)

Perpetual EBIT 300000 Since the company does not have any debt therefore the company is an unlevered firm and also cost of equity Unlevered cost of equity 20 Perpetual Unlevered cash flow Perpetual Free cash flow to firm EBIT1tax rate 300000133 300000 x 67 201000 Value of unlevered firm Perpetual Unlevered cash flow Unlevered cost of equity 201000 20 201000 020 1005000 Hence value of firm 1005000 a Amount of permanent debt borrowed 280000 In case of permanent debt being borrowed at fixed rate of interest we know See Answer

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Ice Cream Sandwich Co. expects EBIT of $300,000 every yearforever. Ice Cream Sandwich Co. currently has no debt and its costof equity is 20%. The firm can borrow at 5%. The corporate tax rateis 33%. The value of the firm is 1005000.Questions:a. what will be the value of the firm if Ice Cream Sandwich Co.borrows $280,000 of permanent debt and uses the proceeds to buyback stock?b. how can Ice Cream Sandwich Co. maximize the value of thefirm? What will be the maximum value if there are no costs tofinancial distress?c. Suppose that with $280,000 of debt, there is a 13%probability of financial distress, in which case the firm will havea present value of $220,000. What is the value of the firm in thiscase? Recall that the value of the firm with $280,000 debt and nocosts to financial distress was $1,097,400.Answer for a. 1097400. b. 1500000 c. 983338. How can I get thoseanswers? Please write in detail calculation, dont use theexcel.