You have been hired as a management consultant by AD
You have been hired as a management consultant by AD Corporation to evaluate whether it has an appropriate amount of debt (the company is worried about a lever aged buyout). You have collected the following information on AD’s current position:
• There are 100,000 shares outstanding at $20 per share. The stock has a beta of 1.15.
• The company has $500,000 in longterm debt outstanding and is currently rated BBB. The current market interest rate is 10% on BBB bonds and 6% on Treasury bonds.
• The company’s marginal tax rate is 40%.
You proceed to collect the data on what increasing debt will do to the company’s ratings:
aIn addition to the existing debt of $500,000.
a. How much additional debt should the company take on?
b. What will the price per share be after the company takes on new debt? (with 2% growth in perpetuity in value)
c. What is the WACC before and after the additional debt?
d. Assume that you are considering a project that has the following earnings in perpetuity and is of comparable risk to existing projects.
Revenues/year .........$1,000,000
Cost of goods sold ........ $400,000 (includes depreciation of $100,000)
EBIT .............. $600,000
Debt payments ........... $100,000 (all interest payments)
Taxable Income ........ $500,000
Tax ............. $200,000
Aftertax profit ......... $300,000
If this project requires an investment of $3,000,000, what is its NPV?
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