Total Market Value of a Firm
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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 1.00x
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 percent debt and 80 percent equity (based on market values) that the cost of equity will increase to 11 percent and that the pre-tax cost of debt will be 10 percent.
If the company makes this change, what would be the total market value of the firm? (The answers are in millions.)
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Solution Summary
This solution is comprised of a detailed explanation and calculation to compute the total market value of the firm in both text and excel files.
Solution Preview
First, we need to find the new amount for total debt and total equity. As total assets is equal to total debt plus total equity, then we can calculate for total debt and total equity as follows: -
Total debt $3,000 million x 20% = $600 million
Total equity $3,000 million x 80% = $2,400 million
Then, we will need to recalculate for the interest expense in order to calculate the new EPS or DPS.
$600 million x 10% = $60 million
Then, we will ...
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