Pennewell Publishing Inc. (PP) is a zero growth company. It currently has zero debt and its earnings before interest and taxes (EBIT) are $80,000. PP's current cost of equity is 10%, and its tax rate is 40%. The firm has 10,000 shares of common stock outstanding selling at a price per share of $48.00.
-Refer to the data for Pennewell Publishing Inc. (PP). PP is considering changing its capital structure to one with 30% debt and 70% equity, based on market values. The debt would have an interest rate of 8%. The new funds would be used to repurchase stock. It is estimated that the increase in risk resulting from the added leverage would cause the required rate of return on equity to rise to 12%. If this plan were carried out, what would be PP's new value of operations?

Question

Quizplus · Accepted Answer

$\begin{aligned}
W A C C &=w_{c} r_{\mathrm{s}}+w_{d}(1-T) r_{d} \
&=(0.7)(0.12)+(0.3)(1-0.4)(0.08)=0.0984=9.84 \%
\end{aligned}$ 
 $\begin{aligned}
V &=F C F / W A C C . \text { Since } g=0, F C F=N O P A T=E B I T(1-T) \
V &=\$ 80,000(1-0.4) / 0.0984=\$ 487,804.878 \approx \$ 487,805
\end{aligned}$