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problem: In finance, as in accounting, two (2) sides of the balance sheet must be equal. To value the other side, we must value the debt & the equity, and then add them together.

 

0% Debt/ 100% Equity

25% Debt/75% Equity

50% Debt/50% Equity

Cash flow to creditors:

 

 

 

Interest

0

$125

$250

Pretax cost of debt

0.05

0.05

0.05

Value of debt:

 

 

 

(Interest/kd)

-

-

-

Cash flow to shareholders:

 

 

 

EBIT

$1,485

$1,485

$1,485

 - Interest

0

$125

$250

Pretax profit

-

-

-

Taxes (@ 34%)

-

-

-

Net income

-

-

-

 + Depreciation

$500

$500

$500

- Capital Expense

$500

$500

$500

+ change in  net  working capital

0

0

0

- Debt amortization

0

0

0

Residual Cash Flow (RCF)

-

-

-

Cost of equity

-

-

-

Value of equity (RCF/ke)

-

-

-

Value of equity plus value of debt

-

-

-

As the firm levers up, how does the rise in value get apportioned between the creditors & the shareholders?

Basic Finance, Finance

  • Category:- Basic Finance
  • Reference No.:- M921355

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