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Jungle Jane's Grocery specializes in purchasing various food items
from around the world and selling them to local customers at its
single location in the U.S. Presently, the firm is financed
entirely with equity. After forecasting the future cash flows of
the firm, discounted at the firm's cost of equity, you estimate
that the firm's value is currently about $35 million. Management is
now considering adding debt to the firm's capital structure. The
firm's cost of equity is 11%, the corporate tax rate is 35%, and
the coupon rate on the new issue of debt will be 6% (the debt is
risk-free and its market value equals its face value). If the firm
sets the perpetual level of debt at $10 million, how will this
change the value of the firm? (That is, what will be the value of
the firm if it issues $10 million in debt?)" |
Compute the value of the firm, using the equation as shown below:
Value of firm = Equity value + (Debt value*Tax rate)
= $35 million + ($10 million*35%)
= $38.50 million
Hence, the value of the firm is $38.50 million.
Jungle Jane's Grocery specializes in purchasing various food items from around the world and selling them...
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