Consider a firm that is currently all-equity financed. Thefirm produces a perpetual EBIT of $100m per annumand has an all-equity cost of capital (required returnon equity) of 10 per cent. The corporate tax rate is 30per cent, and the interest rate on debt is 3 per cent.The company is to be acquired under a LBO, underwhich an initial level of debt of $500m will be taken on,with repayment of $100m per year and interest on theprincipal at the end of each of years 1, 2, and 3. A levelof debt of $200m will then be maintained in perpetuity.a. Calculate the present value of interest tax shield, youmay assume that you can discount any debt-related cashflows at the cost of debt.b. Calculate the value of the firm before LBOc. Calculate the value of the firm following LBO usingthe APV method

Interest tax shield is the tax benefit which is derived by adding debt in the capital structure of…

a. Calculate the present value of interest tax shield, you may assume that you can discount any debt-related cash flows at the cost of debt. b. Calculate the value of the firm before LBO c. Calculate the value of the firm following LBO using the APV method

a. Calculate the present value of interest tax shield, you may assume that you can discount any debt-related cash flows at the cost of debt. b. Calculate the value of the firm before LBO c. Calculate the value of the firm following LBO using the APV method

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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Question

100%

Consider a firm that is currently all-equity financed. The
firm produces a perpetual EBIT of $100m per annum
and has an all-equity cost of capital (required return
on equity) of 10 per cent. The corporate tax rate is 30
per cent, and the interest rate on debt is 3 per cent.
The company is to be acquired under a LBO, under
which an initial level of debt of $500m will be taken on,
with repayment of $100m per year and interest on the
principal at the end of each of years 1, 2, and 3. A level
of debt of $200m will then be maintained in perpetuity.
a. Calculate the present value of interest tax shield, you
may assume that you can discount any debt-related cash
flows at the cost of debt.
b. Calculate the value of the firm before LBO
c. Calculate the value of the firm following LBO using
the APV method

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