EIEIO Agriculture Inc. is a sole proprietorship company that is located in New Bedford Nova Scotia that is owned by your best friend and they have come to you for advice – don’t disappoint them. Your friend is the only owner. The company is currently an un-levered firm. A company in this type of industry has a beta of 1.428571429 and you observe that government t-bills are selling to yield 3% and the market portfolio has an expected return of 10%. Your friend expects that they will be able to earn the required rate of return forever on an expected before tax earnings of $800,000 per year. Note: all final rates carry 6 decimal places.
Assuming that the tax rate is 40 percent, there is no cost for the risk of default and any debt that is issued will have a 4% coupon interest rate, what is:
The current market interest rate for any debt issued by the company is 4 percent for all debt issues.
If the firm issues $500,000 in debt, calculate the WACC and the total value of the firm. Show all of your work.
If the firm issues $1,000,000 in debt, calculate the WACC and the total value of the firm. Show all of your work.
If the firm issues $1,500,000 in debt, calculate the WACC and the total value of the firm. Show all of your work.
Draw a graph for the value of the firm (proposition I) and a separate graph for the cost of equity, cost of debt and the WACC for the firm (proposition II) from the information and calculations in parts a, b and c. When will the value of the firm be maximized? Explain.