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As a consultant to First Responder Inc., you have obtained the following data (dollars in millions). The company plans to pay out all of its earnings as dividends, hence g = 0. Also, no net new investment in operating capital is needed because growth is zero. The CFO believes that a move from zero debt to 20.0% debt would cause the cost of equity to increase from 10.0% to 12.0%, and the interest rate on the new debt would be 8.0%. What would the firm's total market value be if it makes this change? Hints: Find the FCF, which is equal to NOPAT = EBIT(1 %u2013 T) because no new operating capital is needed, and then divide by
(WACC %u2013 g).

Oper. income (EBIT) $800 Tax rate 40.0%
New cost of equity (rs) 12.00% New debt ratio 20.0%
Interest rate (rd) 8.00%

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Answer:

the firm's total market value be if it makes this change is up to 4545.45

Explanation:

  • Step 1. Find the WACC according to the following calculation.

  • Step 2. Set up the variables. WACC = 0.8*12 + 0.2*8*(1-0.4) = 9.6 + 0.96 = 10.56 % ;

  • Step 3. Solve.  FCF = EBIT/WACC = 800*(1-0.4)/0.1056 = $ 4545.45

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