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From the next year onwards, ABC is estimated to have an ebit of $15,000,000. it will...

From the next year onwards, ABC is estimated to have an ebit of $15,000,000. it will also spend $6,000,000 annually on total capital expenditures and increases in net working capital, and have $3,000,000 in depreciation expenses. ABC is currently an all equity firm with a corporate tax rate of 35% and cost of capital of 6%. the interest rate on its debt is 8%. how much should ABC borrow to maximize the value of its firm and why?

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Answer #1

Answer =

Interest expense of $15,000,000,

ABC should borrow to maximize the value of its firm = $ 15,000,000 / 0.08

= $ 187,500,000

Market value of equity today =

FCF = EBIT * (1- Tax) + Dep - Capex - NWC

= $15000000 * ( 1 + .35) +3000000- 6000000

= $ 6750000

Equity value = $6750000 / 0.06

= 112,500,000

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