Question

North Corp. EBIT is $200. It has a debt-equity ratio of 25% and a WACC of 16%. Debt

interest is 12%. Without taxes, what is the value of the equity? What is the value of the

firm? What is the cost of equity capital?

Answer 1

we will find it using the formulas:

$DFL=\frac{EBIT}{EBIT-Interests}$

DFL=0.25

$0.25=\frac{200}{200-Interests}$

Interests=-600

$I=debt\times r$

$debt=\frac{I}{r}=\frac{-600}{0.12}=-5000$

$debt-equity ratio=\frac{L}{E}$

L=5000

$0.25=\frac{5000}{E}$

E=20 000

$value of the firm=E+L=20 000+5000=25000$

$WACC=Ks\times Ws+Kd\times Wd$

$0.16=Ks\times \frac{20 000}{25 000}+0.12\times \frac{5000}{25000}$

$0.16=Ks\times 0.8+0.12\times0.2$

$0.136=Ks\times 0.8$

Ks=0.17 or 17%