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Consider a growing firm that is expected to produce earnings of $10 million next year. The firm's earnings growth rates are 15% per annum. The firm's cost of capital is 20%. I ts tax rate is 0.
1: What is the market value of this firm?
2: What is the firm's P/E ratio if it has no debt?
3: Now assume that the cost of capital for debt of $100 million is 8%, while the cost of capital for the remaining levered equity is 32%. (Again, the weighted average cost of capital is 50%·8%+50%·32% = 20%, so the firm's cost of capital has not changed.) Interest on the $100 million debt is paid out. What is the equity's P/E ratio now?
4: Has the increase in debt increased or decreased the firm's P/E ratio?
Finance is about Gunns Ltd, a company in dealing with forestry products in Australia. The company has also been listed in Australian Stock Exchange. As many companies producing forestry products, even Gunns Ltd is facing various problems. Due to the ..
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