5.Glassmakers has the below characteristics. The premerger debt is $5, the preme

Question

5.Glassmakers has the below characteristics.

The premerger debt is $5, the premerger equity is $10. The risk free rate is 6%. The premerger beta is 1.36. The tax rate is 40%. The cost of debt premerger is 11%. The expected market rate of return is 10%.
The cash flows are : CF0 = 0; CF1 = 4,000,000; Nj = 3; CF2 = 19,000,000; I/YR = 11.29. What is the value of Glassmakers' equity? Value of equity=? (Round your answer to the closest thousand dollars.)

a) $16,019,000

b) $17,111,000

c) $18,916,000

d) $22,111,000

e) $22,916,000

Explanation / Answer

Since, we have been provided with the cash flows and discount rate (11.29%), we need to find the present value of cash inflows with the use of following formula:

Present Value of Cash Inflows = Cash Flow Year 1/(1+Discount Rate)^1 + Cash Flow Year 2/(1+Discount Rate)^2 + Cash Flow Year 3/(1+Discount Rate)^3 + Cash Flow Year 4/(1+Discount Rate)^4

_______

Value of Equity = Present Value of Cash Inflows - Value of Debt

_____________

Solution:

Here, Cash Flow Year 1 to Year 3 = $4,000,000, Cash Flow Year 4 = 19,000,000 and Discount Rate = 11.29%

Using these values in the above formula, we get,

Present Value of Cash Inflows = 4,000,000/(1+0.1129)^1 + 4,000,000/(1+0.1129)^2 + 4,000,000/(1+0.1129)^3 + 19,000,000/(1+0.1129)^4 = $22,111,708

________

Value of Equity = 22,111,708 - 5,000,000 = $17,111,708 or 17,111,000 (which is Option B)

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