An unlevered company with a cost of equity of 15% generates $3 million in earnings before interest
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Question:
An unlevered company with a cost of equity of 15% generates $3 million in earnings before interest and taxes (EBIT) each year. The decides to alter its capital structure to include debt by adding $4 million in debt with a pre-tax cost of 9% to its capital structure and using the proceeds to reduce equity by a like amount as to keep total invested capital unchanged. The firm pays a tax rate of 25%.
Assuming that the company's EBIT stream can be earned into perpetuity and that the debt can be perpetually issued (or rolled).
What is the value of the equity of the levered company?
Related Book For
Equity Asset Valuation
ISBN: 978-0470571439
2nd Edition
Authors: Jerald E. Pinto, Elaine Henry, Thomas R. Robinson, John D. Stowe, Abby Cohen
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