Problem
The conglomerate General Eclectic (GEC) is interested in valuing a financial services company, Infiniti, Inc., which is expected to generate perpetual annual earnings before interest and taxes of $10 million.
• Suppose General Eclectic (GEC) believes in a world without taxes. Infiniti is currently all-equity, and GEC assumes that Infiniti current cost of equity is 10%. What is Infiniti's new value, its new cost of equity and WACC, according to GEC, if Infiniti issues $25 million in debt at 6%. You can assume that the debt will be used to repurchase stock and that the debt will be perpetual.
• How would your answers change if GEC now believes in a world with a corporate tax rate of 25%? You may assume that Infiniti's unlevered value is still $100 million even though the corporate tax rate is now 25%.