FINA 4310-Williams Capital Structure and WACC .Lone Star Industries has a debt t
ID: 2808941 • Letter: F
Question
FINA 4310-Williams Capital Structure and WACC .Lone Star Industries has a debt to equity ratio of 2/3. The required return on the firm's unlevered equity is 16%, and the pre-tax cost of debt is 10%. Sales revenue is expected to remain the same in perpetuity at last year's level of $19,740,000. Variable costs are 60% of sales, and Lone Star is taxed at the corporate rate of40%. If Lone Star were financed by 100% equity, how much would the firm be worth? (Hint: Think how M&M would value the firm.) b Considering that the firm's debt-to-equity is 2/3d, what is the firm's cost of leveraged equity? ieversged oquity-uiyD/EX veraged oquity T- Tc What is the leveraged firm's WACC? Calculate the value of the firm. (Again think M&M) How much of this value is debt and equity? How much cash flow each year do the shareholders have a claim on? Given these cash flows and the cost of equity, how much is the firm's equity worth (show your calculation). (Hint: calculate the after tax cash flows that shareholders would get).Explanation / Answer
Ans a) Firm value = (sales - variable cost) * (1 - tax rate )/ required return on firm's unlevered equity
= 19740000 * .4 * (1 - .4) /.16
= $29610000
Ans b) rleverageequity = runleverageequity + D/E * (runleverageequity - rdebt)(1-tc)
= .16 + 2/3 * (.16 - .1)*.6
= 18.4%
Ans c) rwacc = [D/(D+E) * (1 - tc) * rd + E/(D+E) * rleverageequity]
= 2/5* .6 * .1 + 3/5*.184
= 13.44%
Ans d) Value of firm = (sales - variable cost) * (1 - tax rate )/ rwacc
= 19740000 * .4 * (1 - .4) /.1344
= $35250000
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