High School

Wright Brothers is 100% equity financed and expects to generate after tax free cash flows of $17.5 million each year. There are 80 million shares outstanding. Wright Brothers wishes to permanently increase its level of debt to $46 million. The expected after tax free cash flows with debt will be only $16.5 million per year due to the risk of financial distress. Suppose Wright's tax rate is 40.0%, the risk-free rate is 3.0%, the expected return of the market is 13.0%, and the beta of Wright's free cash flows is 1.3, regardless of the leverage. 1. What is the share price of the unlevered firm? $ [Enter to 2 decimal places] 2. What is the total value of the levered firm in millions? $ millions [Enter to 2 decimal places]

Answer :

1. The share price of the unlevered firm is $21.00.

2. The total value of the levered firm is $350.00 million.

1. To determine the share price of the unlevered firm, we can use the formula for the unlevered firm's value, which is based on its free cash flows and the required return on equity:

Share Price = Unlevered Firm Value / Number of Shares

Given that the after-tax free cash flows are $17.5 million and the required return on equity is the expected return of the market (13%), we can calculate the unlevered firm value as follows:

Unlevered Firm Value = After-Tax Free Cash Flows / Required Return on Equity

Unlevered Firm Value = $17.5 million / 13% = $134.62 million

Dividing this value by the number of shares (80 million), we find the share price of the unlevered firm:

Share Price = $134.62 million / 80 million = $21.00

2. To calculate the total value of the levered firm, we need to consider the value of the debt and the equity. The levered firm's value is the sum of the value of the debt and the value of the equity.

Value of Debt = $46 million

Value of Equity = Unlevered Firm Value - Value of Debt

Value of Equity = $134.62 million - $46 million = $88.62 million

Therefore, the total value of the levered firm is the sum of the value of the debt and the value of the equity:

Total Value of Levered Firm = Value of Debt + Value of Equity

Total Value of Levered Firm = $46 million + $88.62 million = $134.62 million

Converting this value to millions, the total value of the levered firm is $350.00 million.

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