##### (Solution)-LK Inc. is a corporation that has a perpetual earnings of \$8,000,000

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LK Inc. is a corporation that has a perpetual earnings of \$8,000,000 and it pays all earnings in dividends. It is currently 100% equity financed, and has 1,000,000 shares outstanding. Beta for firm LK is 1.2, the risk free rate is 3%, and the market risk premium is 8%. It operates in a country Eleftheria, where there are no taxes.Assume that the required rate on debt is 5%.The Corporation decides to move to a Debt-to-Equity ratio of 2:1, and the CFO is asking you, a lowly intern, to answer the following questions:(1) Calculate the value of the firm before and after the change in leverage.(2) Calculate the required return on equity after the change in leverage.(3) Calculate the beta of the firm's equity after the change in leverage.(4) Calculate the WACC for the firm before and after the change in leverage.(5) How many shares will be outstanding after the change in the debt to equity ratio? What is the price per share? Continuation of the question:The space communists invade Eleftheria and impose a 40% tax rate on the capitalist pigs of LK INC. LK still earns \$8,000,000 perpetually which it pays in dividends. The CFO asks you to evaluate the damage of these communists fellows, and asks you to answer the following questions:(1) Calculate the value of the unleveraged firm. How much of their investment did equity holders lose from the imposition of the tax?(2) What is the new price of the share?For the following parts, assume LK Inc. decided to change their debt to equity ratio to 2:1 before the imposition of the tax:(3) Calculate the value of the leveraged firm. How much of the investment did equity holders lose from the imposition of the tax?(4) Calculate the required return on equity for the leveraged firm.(5) Calculate the WACC of the firm.(6) Suppose LK decides to change its capital structure to 50% equity, what would happen to the price per share? Will it increase or decrease? By what percentage?(7) Suppose LK decides to change its capital structure to 100% equity, what would happen to the price per share? Will it increase or decrease? By what percentage?

Solution ID:10086514 | Question answered on 16-Oct-2016

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