An all-equity firm, forecasts yearly after-tax cash flows/ English
KF, an all-equity firm, forecasts yearly after-tax cash flows of $20 million in perpetuity. The firm’s value is currently $160 million. KF faces a 40% corporate tax rate. KF is considering issuing $60 million of perpetual debt and repurchasing $60 million of its shares using the debt proceeds (i.e., debt increases by $60 million, equity decreases by $60 million, excluding tax effects). The interest rate on the debt will be 8%.
a) What is KF’s cost of unlevered capital (rA) before the debt issuance? b) Use the APV method to calculate KF’s value after the debt issuance. What are the values of the firm’s equity and debt after the debt issuance? c) Calculate the new cost on equity (rE) and weighted average cost of capital (rWACC) after the debt issuance? d) Use the WACC method to calculate KF’s value after the debt issuance. e) (3 pts.) Assume KF is considering investing in a project with a mix of debt and equity different from the firm’s current capital structure. Discuss whether the WACC method or the APV method will be more appropriate to value the new project.
