Question

Use the following data for questions 33-35 General Electrie wants to find the value of a Japanese firm. Pro-For (All Yen figures below are in millions), Revenue Costs Y 200 Y (160) Depreciation Y (10) Interest Y (10) Y 20 Y 12 Pre-Tax After Tax It is expected that these cashflows will occur in perpetuity. Further, the depreciation amount will equal the capital expenditures throughout in the future. Unlevered cost of equity i 20% (in Yens). Interest rate on debt s l0% (inYe Today's spot rate is Yen 100$. 33) Equity value is: a) $ 300,000 b) S 540,000 34) Debt value is: a) $100,000 b) $ 540,000 c)S 700,000 d) $ 739,500 e) none of the above c) $ 739,500 d) $ 1,000,000 e) none of the above 35) Assume a different capital structure with a larger debt amount, say 5 million yens more than the amount assumed above. The firm value will increase by the following amount: c) $ 40,000 d) $ 43,000 e) none of the above a) $ 11,500 b) $ 20,000 12,006, d. 2

Answer 1

33) We know that

EBIT = (Revenue - Cost - Depreciation) = 200 - 160 - 10 =Y 30 million

Tax rate = (After tax income - Pre tax income) / Pre tax income = =(20-12) / 20 = 8 / 20 = 40%

Free cash flow = EBIT(1-tax rate) + Depreciation - Capital expenditure

Since depreciation = capital expenditure

Hence Free cash flow = EBIT (1-tax rate) = 30 (1-40%) = 30 x 60% = Y18 million

As these cash flows will occur till perpetuity,

Value of unlevered firm = Free cash flow / Unlevered cost of Equity = 18 / 20% = Y 90 million

Value of Levered firm = Value of Unlevered firm + tax rate x value of debt

Interest rate = 10% and Interest expense = Y 10 million

Value of debt = Interest expense / Interest rate = 10 million / 10% = Y 100 million

Value of Levered firm = Value of unlevered firm + tax rate x value of debt = 90 + 40% x 100 = 90 + 40 = Y130 million

Value of Equity = Value of Levered firm - Value of debt = 130 - 100 = Y 30 million = Y 30000000

As we know spot rate is Y100/$

therefore Value of Equity = 30000000/ 100 = $300000

Equity value = $300000

Answer is option a)

34) As calculated above Value of debt = Y 100 million = Y 100000000

As we know spot rate is Y100/$

Value of debt = 100000000 / 100 = $1000000

Debt value = $1000000

Answer is option d)

35) Additional debt = Y 5 million = Y 5000000

We know that Value of levered firm = Value of unlevered firm + tax rate x Value of debt

Value of unlevered firm is the value of all equity firm and does not change with addition of debt

Thus Increase in firm value = tax rate x Additional debt = 40% x 5000000 = Y2000000

Thus Increase in firm value = 2000000 / 100 = $ 20000

Answer is option b)