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In the listed company ABC, you are asked to assume that annual profits before interest and tax (EBIT) are risk-free, perpetual and without growth. Next year's profit is expected to be 5,000, while the risk-free interest rate is expected to remain at 5% per annum. Years in the foreseeable future. With regard to the valuation of the company, it is assumed that book depreciation represents the actual cost of maintaining the company's production capacity, that the working capital will not change and all profit after tax is paid as a dividend to the shareholders. The company's tax rate is 20%, while shareholders and bond investors do not pay tax. a) If the company is debt free, what is the value of the company's equity? b) If annual interest expenses amount to 4,000, what will be the respective value of debt and value of equity? c) Is the company value really affected by capital structure? Explain briefly based on your calculations above.

EBK CONTEMPORARY FINANCIAL MANAGEMENT

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter10: Capital Budgeting: Decision Criteria And Real Option

Section: Chapter Questions

Problem 2P

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In the listed company ABC, you are asked to assume that annual profits before interest and tax (EBIT) are risk-free, perpetual and without growth. Next year's profit is expected to be 5,000, while the risk-free interest rate is expected to remain at 5% per annum. Years in the foreseeable future. With regard to the valuation of the company, it is assumed that book depreciation represents the actual cost of maintaining the company's production capacity, that the working capital will not change and all profit after tax is paid as a dividend to the shareholders. The company's tax rate is 20%, while shareholders and bond investors do not pay tax.

a) If the company is debt free, what is the value of the company's equity?

b) If annual interest expenses amount to 4,000, what will be the respective value of debt and value of equity?

c) Is the company value really affected by capital structure? Explain briefly based on your calculations above.

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