Use the information for the question(s)below.
Flagstaff Enterprises expected to have free cash flow in the coming year of $8 million,and this free cash flow is expected to grow at a rate of 3% per year thereafter.Flagstaff has an equity cost of capital of 13%,a debt cost of capital of 7%,and it has a 35% corporate tax rate.
-If Flagstaff currently maintains a .5 debt to equity ratio,then the value of Flagstaff as a levered firm is closest to:

Question

Quizplus · Accepted Answer

First, we need to calculate the weighted average cost of capital (WACC):
WACC = (D/D+E) x Cost of Debt x (1 - Tax Rate) + (E/D+E) x Cost of Equity
WACC = (0.5) x 7% x (1 - 35%) + (0.5) x 13% = 9.9%
Next, we can calculate the present value of the free cash flows:
PV of FCF = (FCF1 / (WACC - Growth rate))
PV of FCF = ($8 million / (9.9% - 3%)) = $107.14 million
Finally, we need to add the value of the tax shield from debt:
Value of tax shield = (Tax rate x Debt) = (35% x 0.5 x $107.14 million) = $18.75 million
Total value of the levered firm = $107.14 million + $18.75 million = $125.89 million
Thus, the closest value is option C, $107 million.

Use the Information for the Question(s)below