LSI recently issued $195,000 of perpetual 9% debt and used the cash to do a stoc
ID: 2772642 • Letter: L
Question
LSI recently issued $195,000 of perpetual 9% debt and used the cash to do a stock repurchase. Earnings for LSI are anticipated to be $83,000 annually before interest and taxes. The company has a dividend payout of 100% of earnings and its unlevered cost of capital is 15%. Corporate taxes for LSI are 40%.
a) What is the unlevered value of LSI??
b) What is the value of the levered firm using the adjusted PV method?
c) What are an investors expectations for the return on equity for the levered company?
d) What is the value of LSI equity using the flow to equity method?
Explanation / Answer
Given
Exstimated earnings = 83,000
Perpetual capital= 195000
Rate of interest on Perpetual capital= 9%
Corporate Tax= 40%
Earning after tax= 83,000*(1-0.4)= 49,800
Total Equity value= ?
a) From the above Unlevered value of LSI = 83,000*0.60/0.15= 332,000$
b)Value of the levereged firm using adjusted PV method= ?
WACC= cost of equity+ cost of debt
= ((215000/410000)*0.15)+ ((195000/410000)*0.09*(1-0.4))
= 0.07865+0.02568
=0.1043329
Value of the firm= 410000/(1+0.1043329)= 371,264.86
c) Investor expects more return on the levered firm as the total earning will be split to the debt and equity holders, in general cost of capital of equity is higher compared to the cost of capital of debt funds, hence a shareholders of the firm whcih is unlevered will receive lower returns compared to levered companies.
d) Value of LSI equity using flow to eqity method= ?
Earning= return on perpetual capital+ equity capital
49,800= 195000*0.09+ equity*0.15
Equity= (49,800-17,550)/0.15
Equity= 32,250/0.15= 215,000$
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.