Gypco expects an EBIT of s10,000 every year forever. Gypco Problem 4. Gypco curr
ID: 2620057 • Letter: G
Question
Gypco expects an EBIT of s10,000 every year forever. Gypco Problem 4. Gypco currently has no debt and its cost of equity is 17 percent. The corporate tax rate is 35 percent. What will the value of the firm if Gypco borrows $15,000 and uses the proceeds to purchase stock? (6 points) can borrow at 7 percent. Suppose Problem 5. Recalculate the value of the firm in Problem 4 by assuming a 40% chance of going bankrupt after 5 years. Bankruptcy costs of$40,000 will be occurred in case of bankruptcy. The discount rate is 14%. (6 points) Problem 6. The MPD Corporation must raise $30 million to finance its current capital budget. A common stock issue could be made at a price of $10 per share; bonds could be issued with an interest rate of 12%. The firm currently has 2,000,000 shares outstanding and $10 million in bonds with an interest rate of 12%. There is no outstanding preferred stock. The firm's tax rate is 30%. What is the indifferent level of EBIT (EBIT*)? (8 points)Explanation / Answer
(4) Gyco's EBIT = $10000, Tax Rate = 40%
NOPAT = EBIT x (1-tax rate) = 10000 x (1-0.35) = $6500
Cost of Equity = 17%
Value of unlevered firm = Vu = 6500 / 0.17 = $ 38235.29
Issuing debt raises the firm value owing to the impact of the interest tax shield associated with debt.
Value of interest tax shield = Interest Rate x Debt x Tax Rate / Interest Rate = 15000 x 0.35 = $ 5250
Value of levered firm = 38235.29 + 5250 = $ 43485.29
(5) Bankruptcy Cost = $40000, Bankruptcy Probability = 40 %
Expected Bankruptcy Cost = 0.4 x 40000 = $ 16000
Discount Rate = 14%
PV of expected bankruptcy cost = 16000 / 1.14^5 = $ 8309.9
Value of firm = 43485.29 - 8309.9 = $ 35175.39
NOTE: please raise a separate query for the solution to the remaining unrelated question.
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