Question

Manufacturing has an expected EBIT of $40,000 per year in perpetuity and a tax rate of 35%. The firm currently has no debt. Its cost of debt is 8% and unlevered cost of capital is 14%. (i) What is the firm's current (a) firm value and (b) equity value

Answer 1

Answer and Explanation:

The computation is shown below:

Given that

EBIT = $40,000

Unlevered cost of capital = 14%

Cost of debt = 8%

tax rate = 35%

based on the above information,

(i)

(a) Current firm value is

Value of a perpetuity = FCFF ÷ Cost of capital

where,

cost of capital= cost of equity

= $40,000 ÷ 14%

= $285,714

b. And, the equity value would be $285,714 as the present debt is zero