An all equity firm is expected to generate perpetual EBIT of $50 million per year forever. The corporate tax rate is 0% in a fantasy no tax world. The firm has an unlevered (asset or EV) Beta of 1.0. The risk-free rate is 5% and the market risk premium is 6%. The number of outstanding shares is 10 million.
1. Calculate the existing WACC of this all equity or unlevered firm. Calculate the total value of this all equity firm and the existing share price.
2. The firm decides to replace part of the equity financing with perpetual debt. The firm issues $100 million of permanent debt at an interest rate of 5%, and repurchases $100 million of equity.
A. Find the new value of the levered firm.
B. Find the new number of shares outstanding, and the new share price.
3. Calculate the new equity Beta, cost of equity, and WACC following this capital structure change.