Benson, Athavale & Kemper (BAK) started a manufacturing facility in the last cen

Question

Benson, Athavale & Kemper (BAK) started a manufacturing facility in the last century. This firm, profitable since inception produces steering units for the automotive industry. The 3 founders have been averse to debt. Presently, BAK has 20 million shares outstanding trading at $ 25. The CFO Dawn Strong is looking at a proposal to buyout a competitor for $ 100 million. The entrepreneurs expect pre-tax earnings to increase by $ 20 million in perpetuity. Dawn computes the cost of capital to be 10%. She is a recent graduate from a MBA program and knows that some debt will increase the value of the firm and she plans to evaluate this project by borrowing the required funds. Dawn finds out that the firm can sell 30 year AAA bonds with a 6% coupon. She opines that the firm with a capital structure around 25% debt will help increase its value and not worry the shareholders or the financial markets. The firm is in the 40% tax bracket.

Question: CONSTRUCT A MARKET VALUE BALANCE SHEET IF EQUITY IS SOLD.

Please answer the actual question being asked and not just copy and paste from another similar question that is answering something else.

Explanation / Answer

These earnings are expected to increase in perpetuity

Cost of capital =10%.

Capitalizing the increased earnings at the cost of capital = increase in earnings/cost of capital

=$9,300,000/10%

=$93,000,000.

Market value of the firm =number of common stock * current price+Capitalized value of earnings

$25 *21,000,000 +$93,000,000.

=$618,000,000.

Therefore, market value of the equity is $618 million.

=

Particulars Amount Common stock (existing) $200,000,000.00 Additional funds required $100,000,000.00 Total funds required $300,000,000.00 Debt % is 25% of the total funds required =300 million*25% $75,000,000.00 Remainings funding done with equity $25,000,000.00 Current market value of the share $25 Additional stock issued 1000000 Total number of common stock outstanding 21000000

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