You own your own firm and you need to raise $50 million to fund an expansion....

 

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You own your own firm and you need to raise $50 million to fund an expansion. Following the expansion, your firm will be worth $75 million in its unlevered form. You want to go ahead with the expansion, but you are concerned that you may not be able to maintain ownership of over 50% of your firm's equity. In other words, you are concerned that if you use equity to finance the expansion, you may lose control of your firm. Assume that capital markets are perfect except for the existence of corporate taxes and that your firm pays 21% of earnings in taxes. If you want to maintain ownership of at least 50%, then the minimum amount of permanent debt that you must issue to fund the expansion is closest to: A) $19 million. B) $14 million. C) $16 million. D) $20 million. Answer: B Explanation: VU = $75 million % Ownership = % ownership = = VL - new debt - new equity % ownership = VL_ Given: VL VU+ TCD New equity = $50 million needed for expansion - the amount of new debt: - new debt $75 million+ .21 (debt) - debt - ($50 million - debt) $75 million+ 21(debt) - debt $75 million-21 (debt) $75 million-.79(debt) = .50 (given we want 50% ownership) $25 million + .21(debt) = .50($75 million - .79(debt)) $50 million + 1.79(debt) = $75 million Debt = $25 million 1.79 = $13.966 millio You own your own firm and you need to raise $50 million to fund an expansion. Following the expansion, your firm will be worth $75 million in its unlevered form. You want to go ahead with the expansion, but you are concerned that you may not be able to maintain ownership of over 50% of your firm's equity. In other words, you are concerned that if you use equity to finance the expansion, you may lose control of your firm. Assume that capital markets are perfect except for the existence of corporate taxes and that your firm pays 21% of earnings in taxes. If you want to maintain ownership of at least 50%, then the minimum amount of permanent debt that you must issue to fund the expansion is closest to: A) $19 million. B) $14 million. C) $16 million. D) $20 million. Answer: B Explanation: VU = $75 million % Ownership = % ownership = = VL - new debt - new equity % ownership = VL_ Given: VL VU+ TCD New equity = $50 million needed for expansion - the amount of new debt: - new debt $75 million+ .21 (debt) - debt - ($50 million - debt) $75 million+ 21(debt) - debt $75 million-21 (debt) $75 million-.79(debt) = .50 (given we want 50% ownership) $25 million + .21(debt) = .50($75 million - .79(debt)) $50 million + 1.79(debt) = $75 million Debt = $25 million 1.79 = $13.966 millio

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To solve this problem we need to determine the amount of debt that needs to be issued in order to fu... View the full answer