Question: Sandy-Candy," a hot new chewing gum company is for sale for $2,000,000. Henry is interested in buying the company and is exploring various financing alternatives. He knows that the interest rate on debt is rD =9%, corporate tax rate is TC = 36% and the cost of capital of the purchase is rU = 12%. Henry estimates that ‘Sandy-Candy' has a free cash flow (FCF) of $300,000 each year.
a. What will be the market value of Sandy Candy if Henry does not take a loan?
b. What will be the market value of Sandy Candy if Henry takes a $1,200,000 loan. Assume that the loan is paid by out of Sandy Candy's earnings, and that the interest is an expense for tax purposes.
c. What will be Sandy Candy's cost of equity rE for the two cases above?
d. What will be the Sandy Candy's WACC for the two cases above?