Consider firm B as an unlevered firm and firm C as a levered firm with target debt-to-equity ratio (B/S) = 1. Both firms
Posted: Fri Jul 01, 2022 7:42 am
Consider firm B as an unlevered firm and firm C as a leveredfirm with target debt-to-equity ratio (B/S) = 1.Both firms have exactly the same perpetual net operating income,EBIT = 360, before taxes. The before-taxcost of debt, rb, is the same as the risk-free rate. The corporatetax rate = 0.35. Given the following marketparameters,E(Rm) = .12 σ2m=.0144 Rf=.05 βB = l βC =l.5a) Find the cost of capital and value of each firm.b) Both companies are considering a project, which would cost $120,and the EBIT(after tax) is $11 per yearin perpetuity. The standard deviation of the project cash flows is0.11 and the correlation between theunlevered cash flows of the project and the market, ρjm, is 0.75.Calculate the value of this project to firmsB and C, respectively. What do the results of this evaluation tellyou about leverage in a world withcorporate taxes but no personal taxes?