Calculating Total Market Value
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A consultant has collected the following information regarding Young Publishing:
Total assets $3,000 million Tax rate 40%
Operating income (EBIT) $800 million Debt ratio 0%
Interest expense $0 million WACC 10%
Net income $480 million M/B ratio 1.00 x
Share price $32.00 EPS = DPS $3.20
The company has no growth opportunities (g = 0), so the company pays out all of its earnings as dividends (EPS = DPS). The consultant believes that if the company moves to a capital structure financed with 20% debt and 80% equity (based on market values) that the cost of equity will increase to 11% and that the pre-tax cost of debt will be 10%.
If the company makes this change, what would be the total market value (in millions) of the firm?
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The solution provides detailed calculations and explanations for the problem.
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First, find the new WACC: WACC = (0.8(0.11)) + (0.2(1-0.4)0.1) = 0.1
(See the formula for WACC in reference ...
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