Marpor Industries has no debt and expects to generate free cash flows of $17 mil

Question

Marpor Industries has no debt and expects to generate free cash flows of $17 million each year. Marpor believes that if it permanently increases its level of debt to $30 million, the risk of financial distress may cause it to lose some customers and receive less favorable terms from its suppliers. As a result, Marpor's expected free cash flows with debt will be only $16 million per year. Suppose Marpor's tax rate is 30%, the risk free rate is 4%, the expected return of the market is 12%, and the beta ofMarpor's free cash flows is 1.3 (with or without leverage).

a. Estimate Marpor's value without leverage.

b. Estimate Marpor's value with the new leverage.

a. Estimate Marpor's value without leverage.

Marpor's value without leverage is $__ million. (Round to the nearest integer.)

b. Estimate Marpor's value with the new leverage.

Marpor's value with the new leverage is $__ million. (Round to two decimal places.)

Explanation / Answer

a)

As per CAPM

Expected Rate of return = risk free rate +( expected return of the market - risk free rate)*Beta

Expected Rate of return = 4 + (12-4)*1.3

Expected Rate of return = 14.40%

Marpor's value without leverage = Expected Free Cash Flow/Expected Rate of return

Marpor's value without leverage = 17/14.40%

Marpor's value without leverage = $ 118.06 Million

b)

As per CAPM

Expected Rate of return = risk free rate +( expected return of the market - risk free rate)*Beta

Expected Rate of return = 4 + (12-4)*1.3

Expected Rate of return = 14.40%

Marpor's value with the new leverage = Expected Free Cash Flow/Expected Rate of return   + Debt *tax rate

Marpor's value with the new leverage = 16/14.4% + 30*30%

Marpor's value with the new leverage = $ 120.11 Million

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