Mercer Inc. has a debt-to-equity ratio of 0.40. The required return on the company’s unlevered equity is 12%, and the pr

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Mercer Inc. has a debt-to-equity ratio of 0.40. The required
return on the company’s unlevered equity is 12%, and the pretax
cost of the firm’s debt is 8%. Sales revenue for the company is
expected to remain stable indefinitely at last year’s level of
$18,000,000+($100,000x3). Variable costs (including SG & A
expenses) are 65 percent of sales. The corporate tax rate is
26%+(1%x3). The company distributes all its earnings as dividends
at the end of each year.
a. If the company were financed entirely by equity, how much
would it be worth?
b. What is the required return on the company’s levered
equity?
c. Use the weighted average cost of capital (WACC) approach to
calculate the value of the company. What is the value of the
company’s equity? What is the value of the company’s debt?
d. Use the flow to equity (FTE) approach to calculate the value
of the company’s equity (Hint: use the value of debt calculated in
part c to calculate interest expense).