Chapter 18, Problem 27P

Gartner Systems has no debt and an equity cost of capital of 10%. Gartner’s current market capitalization is $100 million, and its free cash flows are expected to grow at 3% per year. Gartner’s corporate tax rate is 35%. Investors pay tax rates of 40% on interest income and 20% on equity income.

1. a. Suppose Gartner adds $50 million in permanent debt and uses the proceeds to repurchase shares. What will Gartner's levered value be in this case?
2. b. Suppose instead Gartner decides to maintain a 50% debt-to-value ratio going forward. If Gartner's debt cost of capital is 6.67%, what will Gartner's levered value be in this case?