Kitto Electronics Data
Kitto Electronics expects an EBIT of $200,000 for Year-1.EBIT is expected to grow at 6% thereafter.The tax rate is 25%.In order to support growth, Kitto must reinvest 20% of its EBIT in net operating assets.Kitto has $300,000 in 8% debt outstanding, and a similar company with no debt has a cost of equity of 11%.
-Refer to data for Kitto Electronics.According to the compressed adjusted present value model, what is Kitto's unlevered value?
A) $1,782,000
B) $1,980,000
C) $2,200,000
D) $2,420,000
E) $2,662,000

Question

Quizplus · Accepted Answer

To calculate the unlevered value using CAPV model we need to follow the given steps:

Step 1: Calculate the value of the firm at year 1

EBIT(Year-1) = $200,000
Reinvestment rate = 20%
Net operating assets (NOA) at year 0 = 0 (assumed)
NOA(Year-1) = EBIT(Year-1) x Reinvestment rate = $40,000
Free cash flow to firm (FCFF) = EBIT(Year-1) - Taxes + Depreciation - Reinvestment = $150,000

PV of FCFF(Year 2-infinite) = $150,000 / (0.11 - 0.06) * (1 - (1 + 0.06) / (1 + 0.11)^5) = $2,200,000

Value of the firm at year-1 = PV of FCFF(Year 2-infinite) + NOA(Year-1) = $2,200,000 + $40,000 = $2,240,000

Step 2: Calculate the value of the unlevered firm

Value of the unlevered firm = Value of the levered firm + Market value of debt - Cash

Market value of debt = $300,000
Cash = 0 (not given)
Value of the levered firm = $2,240,000
Value of the unlevered firm = $2,240,000 + $300,000 - 0 = $2,540,000

Therefore, the correct answer is C) $2,200,000.

Kitto Electronics Data Kitto Electronics Expects an EBIT of $200,000 for Year-1.EBIT Is