Farmers Alliance Limited is considering investing in new equipment with the initial cost of project/investment to be $100,000. This project is expected to generate EBIT of $15,000 per year forever (perpetuity). This project or investment can be financed either with $100,000 in equity (assume from internally generated fund) or with $40,000 of debt and $60,000 equity. The shareholders required return on an all equity financed project in this risk class is 10%. The firm's marginal tax rate is 40%. The cost of any debt is 5% before taxes. Note that in the world of Modigliani & Miller, all cash flows are perpetual and debt does not mature. Required: (i) Use the flow to equity method to calculate the value of the project’s net worth to equity holders.

FINANCIAL ACCOUNTING
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ISBN:9781259964947
Author:Libby
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Chapter1: Financial Statements And Business Decisions
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Farmers Alliance Limited is considering investing in new equipment with the initial cost
of project/investment to be $100,000. This project is expected to generate EBIT of
$15,000 per year forever (perpetuity). This project or investment can be financed either with $100,000 in equity (assume from internally generated fund) or with $40,000 of debt and $60,000 equity. The shareholders required return on an all equity financed project in this risk class is 10%. The firm's marginal tax rate is 40%. The cost of any debt is 5% before taxes. Note that in the world of Modigliani & Miller, all cash flows are perpetual
and debt does not mature.
Required:

(i) Use the flow to equity method to calculate the value of the project’s net worth to equity holders.

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