Presume you are working on a big new idea for your firm. The projected EBIT of $5 million starting next year (t = 1) with a growth rate of
3.50% over the foreseeable future thereafter. This endeavor will require a substantial investment and you will have to convince
investors to provide you the capital to do so. Your firm will consider all types of financing options, but the first critical step in your
analysis is figuring out the present value of the cash flows of the new business. Your research has revealed the following
information: similar businesses have a beta asset of 2.00, the riskfree rate is 2.00% and the expected market risk premium (the
average difference between the market return and the risk-free rate) is 3.50%. The corporate tax rate is 35% and interest payments
on debt are tax deductible. You are tasked to figure out the value of the business under various financing alternatives, including long-term
loan/debt. You are considering a loan of $25 million in perpetuity at an interest rate of 4%. Realizing that the chances of
bankruptcy are negligible with this amount of ongoing debt on your balance sheet, and the riskiness of the tax shield of debt is the same
as the riskiness of debt, you are seriously contemplating recommending taking on the debt.
a. Estimate of the total value of new business given the situation
b. In case you decide to take on $25 million of debt in perpetuity. The growth rate in the cash flows to equity holders between time t = 1 and time t = 2 will be ?
Big new ideaa. Estimate of the total value of new business given the situationTotal value of the business = NPV at the cost of equity as the discount rate + present value of taxsavingsCost of…