Sunshine Trading Company (STC) has an expected EBIT of $30,000 in perpetuity, and a tax rate of 40%. Interest rate on STC’s debt is 8%, and its return on equity is 13.12%. Debt-equity ratio of STC is 0.6, or 3/5. Blackstone Inc (BI) is an all-equity firm, which is identical to STC, except for the capital structure.
(1) What is the value of STC?
(2) What is the value of BI?
(3) What is the rate of return on BI shares?
Sol:
1.
STC
Given , EBIT = $30000
Less Interest @ 8% = 2400
EBT 27600
Less Tax @ 40% = 11040
EAT 16560
Return on equity(ROE) = 13.12%
ROE = Net Income
Shareholder's Equity
or, 13.12% = 16560
Shareholder's Equity
Shareholder's Equity ( Equity Capital) = 16560
13.12%
= $ 126,220
Debt /Equity =0.6
Debt /126220 =0.6
Debt = 0.6 *126220
= $ 75732
Total capital = equity capital + debt capital
= $ 126220 +$ 75732
= $ 201952
Hence , the value of STC = $ 201952
2. Value of BI (Blackstone INC)
Since the company BI is identical to STC , it means BI is similar to STC
Here, All capital are equity only
Total capital = Equity capital + Debt capital
= $ 201952 +0
= $ 201952
Therefore, the value of BI = $ 201952
3. Rate of return on BI shares
(RR) = Kd *( 1-tax) * debt capital + Ke * Equity capital
Total capital Total capital
= 0 + 13.12% * 201952
201952
=13.12%
Hence , the rate of return equals to equity rate , if there is no debt.
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