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Verify that, in either case, EPS is $4.05 when EBIT is $47.7 million. According to M&M Proposition II (no taxes), the cost of equity is:

Re = Ra + (Ra - Rd) X (D/E) = 16% + (16% - 13%) X 2 = 22%

With no debt, Gypco's WACC is 17 percent. This is also the unlevered cost of capital. The aftertax cash flow is $10,000 X (1 - .35) = $6,500, so the value is just VU = $6,500/.17 = $38,235.

After the debt issue, Gypco will be worth the original $38,235 plus the present value of the tax shield. According to M&M Proposition I with taxes, the present value of the tax shield is TC X D, or .35 X $15,000 = $5,250, so the firm is worth $38,235 + 5,250 = $43,485.

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