As a consultant to First Responder Inc., you have obtained the following data (dollars in millions). The company plans to pay out all of its earnings as dividends, hence g = 0. Also, no net new investment in operating capital is needed because growth is zero. The CFO believes that a move from zero debt to 20.0% debt would cause the cost of equity to increase from 10.0% to 12.0%, and the interest rate on the new debt would be 8.0%. What would the firm's total market value be if it makes this change? Hints: Find the FCF, which is equal to NOPAT = EBIT (1 %u2013 T) because no new operating capital is needed, and then divide by

(WACC %u2013 g).

Oper. income (EBIT) $800 Tax rate 40.0%

New cost of equity (rs) 12.00% New debt ratio 20.0%

Interest rate (rd) 8.00%

Question

Business

Zayden Brewer

23 October, 13:15

As a consultant to First Responder Inc., you have obtained the following data (dollars in millions). The company plans to pay out all of its earnings as dividends, hence g = 0. Also, no net new investment in operating capital is needed because growth is zero. The CFO believes that a move from zero debt to 20.0% debt would cause the cost of equity to increase from 10.0% to 12.0%, and the interest rate on the new debt would be 8.0%. What would the firm's total market value be if it makes this change? Hints: Find the FCF, which is equal to NOPAT = EBIT (1 %u2013 T) because no new operating capital is needed, and then divide by

(WACC %u2013 g).

Oper. income (EBIT) $800 Tax rate 40.0%

New cost of equity (rs) 12.00% New debt ratio 20.0%

Interest rate (rd) 8.00%

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Answers (1)

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Rey Oneill · Answer 1

the firm's total market value be if it makes this change is up to 4545.45

Explanation:

Step 1. Find the WACC according to the following calculation.

Step 2. Set up the variables. WACC = 0.8*12 + 0.2*8 * (1-0.4) = 9.6 + 0.96 = 10.56 %;

Step 3. Solve. FCF = EBIT/WACC = 800 * (1-0.4) / 0.1056 = $ 4545.45