Necrosis Health Care Inc. is a North American health services company. The compa
ID: 2727366 • Letter: N
Question
Necrosis Health Care Inc. is a North American health services company. The company is headquartered in Panacea Florida, and is listed on the New York Stock Exchange. Necrosis is an all-equity firm. Management expects EBIT to be $1 billion in perpetuity starting one year from now. The cost of equity for Necrosis is 9%. Assume that the tax rate is 30% and that the required return of unlevered shareholders is 9%. Find the value of the firm if it is all-equity financed. Suppose that senior management of Necrosis decide to waste 10% of EBIT annually (in perpetuity) on perks like private jets, extravagant parties, retainers for sports celebrities, box seats at events, etc. Considering the reduced operating cash flow due to these agency costs, what is the value of the firm if it is all-equity financed? Suppose that Necrosis borrows $3,667 billion and uses the funds to repurchase shares. What is the value of the firm after the recapitalization? Continue to assume that 10% of EBIT is lost due to agency costs annually. Suppose that Necrosis recapitalizes as described in the last question. Assume that the increased debt causes management to reduce their wasteful spending to 5% of EBIT. What is the value of the firm after the recapitalization? What is the value of the firm if it is all-equity financed? $ billion (Round to three decimal places.) Suppose that senior management of Necrosis decide to waste 10% of EBIT annually (in perpetuity) on perks like private jets, extravagant parties, retainers for sports celebrities, box seats at events, etc. Considering the reduced operating cash flow due to these agency costs, what is the value of the firm if it is all-equity financed? $ billion (Round to three decimal places.) Suppose that Necrosis borrows $3,667 billion and uses the funds to repurchase shares. What is the value of the firm after the recapitalization? Continue to assume that 10% of EBIT is lost due to agency costs annually. $ billions (Round to three decimal places.) Suppose that Necrosis recapitalizes as described in the last question. Assume that the increased debt causes management to reduce their wasteful spending to 5% of EBIT. What is the value of the firm after the recapitalization? $ billion (Round to three decimal places.)Explanation / Answer
Part A
Value of unlevered firm = EBIT x (1-t)/ R
= 1,000,000,000 x (1-0.30)/0.09
= 7,777,777,778 or 7.77 billion
Part B
New EBIT = 1,000,000,000 x (1-0.10)
= 900,000,000
Value of unlevered firm = EBIT x (1-t)/ R
= 900,000,000 x (1-0.30)/0.09
= 7,000,000,000 or 7 billion
Part C
Value of levered firm =value of unlevered firm + D x t
= 7.77 billion + 3.667 x 0.30 billion
= 8.87 billion
Part d
New EBIT = 1 billion x (1-0.05) = 0.95 Billion
Value of levered firm =value of unlevered firm + D x t
= 0.95 x (1-0.30)/0.09 + 3.667 x 0.30 billion
= 7.39 billion +1.1001 billion
= 8.49 Billion
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