Lone Star Industries has just issued £160,000 of perpetual 10 per cent debt and used the proceeds to repurchase equity. The company expects to generate

£75,000 of earnings before interest and taxes in perpetuity. The company distributes all its earnings as dividends at the end of each year. The firm’s unlevered cost of capital is 18 per cent, and the corporate tax rate is 28 per cent.

(a) What is the value of the company as an unlevered firm?

(b) Use the adjusted present value method to calculate the value of the company with leverage.

(c) What is the required return on the firm’s levered equity?

(d) Use the flow to equity method to calculate the value of the company’s equity.