Best Bagels, Inc.(BB)
Best Bagels, Inc.(BB) currently has zero debt.Its earnings before interest and taxes (EBIT) are $130,000, and it is a zero growth company.BB's current cost of equity is 13%, and its tax rate is 25%.The firm has 30,000 shares of common stock outstanding selling at a price per share of $25.
-Refer to the data for Best Bagels, Inc.(BB).BB is considering moving to a capital structure that is comprised of 20% debt and 80% equity, based on market values.The debt would have an interest rate of 8.2%.The new funds would be used to repurchase stock.It is estimated that the increase in risk resulting from the additional leverage would cause the required rate of return on equity to rise to 13.9%.If this plan were carried out, what would BB's new value of operations be?
A) $789,474
B) $821,053
C) $853,895
D) $888,051
E) $923,573

Question

Quizplus · Accepted Answer

The correct answer is A.The new value of operations is $789,474. This is calculated as follows:EBIT = $130,000Interest expense = $16,400 (8.2% * $200,000)EBT = $113,600Taxes = $28,400 (25% * $113,600)Net income = $85,200Cost of equity = 13.9%Value of equity = $85,200 / 13.9% = $613,669Value of debt = $200,000Value of operations = $613,669 + $200,000 = $789,474

Best Bagels, Inc.(BB) Best Bagels, Inc.(BB) Currently Has Zero Debt.Its Earnings Before Interest