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 0 and there is no cost for the risk of default, what is:
the required rate of return for the un-levered firm. Show all of your work.
the market value of the un-levered firm using proposition I. Show all of your work.
the WACC for the firm using proposition II. Show all of your work.
If the firm were to issue $2,000,000 in debt with a 4 percent coupon, calculate the market value of the firm and the WACC for the levered firm. Show all of your work.