Libby Co. is an unlevered firm. Investors currently expect a 12.75% return on the company’s equity....

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Libby Co. is an unlevered firm. Investors currently expect a12.75% return on the company’s equity. The company is subject to a24% corporate tax rate.
If earnings before taxes are expected to be $15.85m per yearforever, calculate the total value of this company.
Now suppose this company wants toshift its capital structure to add debt. It wants to issue $31.5million of perpetual debt at a cost of 5.5%.
Use the FTE method to calculate the value of the company’sequity after the recapitalization.
What is the total value of the company after therecapitalization?
Using MMII with taxes, what should be the total value of thecompany after issuing the debt?
What is the debt-equity ratio of this company after therecapitalization?
Suppose the levered company is lookingto invest in a new project. The project costs $27 million and willbe financed at the debt-equity ratio you calculated in d. Theproject generates EBIT of $5.9 million in perpetuity.
Would you advise Libby to invest in this project? (Hint: usethe FTE method…be sure to show how much borrowing you will do andwhat annual interest costs will be).

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3.6 Ratings (422 Votes)

a Before tax earnings 15850000 After tax earnings Before tax earnings 1 tax rate 158500001024 12046000 Total value of the company after tax earnings return on equity 1204600001275 9447843137 Total value of See Answer

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Libby Co. is an unlevered firm. Investors currently expect a12.75% return on the company’s equity. The company is subject to a24% corporate tax rate.If earnings before taxes are expected to be $15.85m per yearforever, calculate the total value of this company.Now suppose this company wants toshift its capital structure to add debt. It wants to issue $31.5million of perpetual debt at a cost of 5.5%.Use the FTE method to calculate the value of the company’sequity after the recapitalization.What is the total value of the company after therecapitalization?Using MMII with taxes, what should be the total value of thecompany after issuing the debt?What is the debt-equity ratio of this company after therecapitalization?Suppose the levered company is lookingto invest in a new project. The project costs $27 million and willbe financed at the debt-equity ratio you calculated in d. Theproject generates EBIT of $5.9 million in perpetuity.Would you advise Libby to invest in this project? (Hint: usethe FTE method…be sure to show how much borrowing you will do andwhat annual interest costs will be).