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Unlev Inc., an unlevered firm, has perpetual expected earnings before interest and taxes of $6.6 million...

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Finance

Unlev Inc., an unlevered firm, has perpetual expected earningsbefore interest and taxes of $6.6 million per year, a tax rate of34.00% and a beta of 1.5. The risk-free rate is 3.75% and themarket risk-premium is 5.50%. Management is considering buying someof its stock back through an issue of debt. The firm will beissuing 5,280 bonds at a coupon rate of 7.00%. The face value of abond = $1,000. The bonds will be offered at par.

a. What is the cost of equity of the unlevered firm?

b. What is the value of the unlevered firm?

c. What is the value of the levered firm?

d. What is the levered firm’s cost of capital?

e. Which firm (levered or unlevered) has the highest value?Discuss how leverage affects the value of a firm and whether it isoptimal for firms to maintain a 100% leverage structure?

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