Redhawk Enterprises expects EBITDA (a proxy for cash profits) to be $85,000 a year in perpetuity. The firm can borrow at 9% but currently has no debt. Its unlevered cost of equity capital is 15% and its effective tax rate is 40%. Assume interest expense is tax deductible.
a. What is the value of Redhawk Enterprises as an all-equity firm (Vu)?
b. Redhawk wants to recapitalize the firm by issuing $250,000 in debt and buy back an equal amount of stock. What is the value of the levered firm (VL) after the recapitalization?
c. Using the value of the levered firms (VL) from part (B) above, what is value of the Equity?
d. What is the cost of equity for the levered firms?
e. What is Redhawk’s required return on assets or WACC after the recapitalization?