Question 16: (Capital Structure) A consultant has collected the following inform

Question

Question 16: (Capital Structure)

A consultant has collected the following information regarding Laure Manufacturing:

Operating income (EBIT) $600 million, Interest expense $0, Tax rate 35%, Debt $0, Cost of equity 7%, WACC 7% . The company has no growth opportunities (g = 0), so the company pays out all of its earnings as dividends . Larue can borrow money at a pre-tax rate of 6%. The consultant believes that if the company moves to a capital structure consisting of 30% debt and 70% equity (based on market values), which would require taking on debt in the amount of $1,728.21 million, that the cost of equity will increase to 8% and the pre-tax cost of debt will remain at 6%, but the value of the firm will rise.  

-Is the consultant correct?

-If the company makes this change, what will be the increase in total market value for the firm?

Explanation / Answer

Yes, The consultant is correct

Exsisting Proposed EBIT 600 600.00 Intt 0 103.69 EBT 600 496.31 Tax 210 173.71 EAT 390 322.60 Ke 0.07 0.08 Value of Equity 5571.429 4032.498 Value of debit 0 1728.21 Total Value of Firm 5571.429 5760.708

Related Questions

Navigate

• Browse (All)
• Browse Q
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.