The following information has been presented to you about the Gibson Corporation

Question

The following information has been presented to you about the Gibson Corporation. (Total assets ... $3,000 million Tax rate ... 40%) (Operating income (EBIT) ... $800 million Debt ratio ... 0%) (Interest expense ... $0 million WACC ... 10%) ( Net Income ... $480 million M/B ratio ... 1.00x) (Share Price ... $32.00 EPS = DPS ... $3.20) ... The company has no growth opportunities (g=0), so the company pays out all of its earnings as dividends (EPS = DPS). The consultant believes that if the company moves to a capital structure financed with 20% debt and 80% equity (based on market values) that the cost of equity will increase to 11% and that the pre-tax cost of debt will be 10%. If the company makes this change, what would be the total market value (in millions) of the firm? a) $3,200 b) $3,600 c) $4,000 d) $4,200 e) $4,800

Explanation / Answer

There seems to be an error in the WACC calculation.

New Wacc = 0.2*0.1*(1-0.4) + 0.8*0.11 = 0.012 + 0.088 = 0.1 = 10%

Value of the firm = FCF / WACC = 800 million * (1-0.4) / 0.1 = 800 million * 0.6 / 0.1 = 4,800 million.   

Option E is correct

Please rate me. Thanks a lot.

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