Question

Cornerstone Corporation expects an EBIT of $22,500 every year forever. The company currently has no debt, and its cost of equity is 13.9 percent. The company can borrow at 8.7 percent and the corporate tax rate is 21 percent.

What is the current value of the company?
Note: Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.

Answer 1

To calculate the current value of Cornerstone Corporation with perpetual EBIT of $22,500 and a cost of equity of 13.9%, subtract the tax from EBIT and divide by the cost of equity, resulting in a current value of $127,878.42.

Step-by-step explanation:

Valuation of Cornerstone Corporation

The question relates to the valuation of Cornerstone Corporation using the concept of perpetual cash flows, given that it has a constant EBIT (Earnings Before Interest and Taxes) of $22,500. To calculate the current value of the company without any debt, we use the formula for the value of perpetual cash flows: Value = EBIT x (1 - Tax Rate) / Cost of Equity.

First, we compute the after-tax EBIT by subtracting taxes which is calculated as: $22,500 x (1 - 0.21) = $17,775.

Next, we determine the value of the company by dividing the after-tax EBIT by the cost of equity: $17,775 / 0.139 = $127,878.42.

Thus, the current value of Cornerstone Corporation, with no debt and just equity financing, is $127,878.42.