Answer Happy

The Flying Dutchman Inc. (henceforth, Flying) is a manufacturer of luxury yachts and ships for cruise lines and high net worth individuals. Flying has an excellent reputation for quality work delivered on budget, a two year backlog of unfilled orders, and consequent stable and predictable profits. The current chair of the board, Mr. L. John Silver, is also the founder of the company and the principal shareholder. Primarily because of Mr. Silver's aversion to leverage, Flying is currently 100% equity financed, with 50 million shares outstanding, currently trading at $15 each. Flying is expected to generate free cash flows of $67.5 million next year expected to grow at 3% in perpetuity. The corporate tax rate is 20%. The market risk premium is 6.5% and the treasury rate is 5.5%. Flying's current equity beta equals 1. 3(a) A board member, Ms. Frances Drake, recently proposed that Flying should undertake a leverage recapitalization and maintain a 50% fixed debt ratio at a cost of debt of 8%. What will be Flying's value if this recapitalization plan is undertaken? Is Flying currently undervalued? (7 points)