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?LoveFinderrz — with two "R's" and a "Z" — is a firm that runs a matchmaking app of the same name
?LoveFinderrz — with two "R's" and a "Z" — is a firm that runs a matchmaking app of the same name. The same really dumb, really forgettable name. Like a really dumb, uncreative, super sweaty name.
LoveFinderrz expects to earn pre-tax operating income of $11.36 billion each year going forward in perpetuity. The firm has an unlevered cost of capital of 13.5% per annum and is expected to continue to pay corporate tax at a rate of 37.5% for the forseeable future. LoveFinderrz also has $68.19 billion of interest-only debt outstanding that currently trades at par. This level of debt financing, which the firm intends to maintain permanently, attracts no costs of financial distress.
Assume that LoveFinderrz exists in a world where the only capital market imperfection is the presence of corporate taxes.
A) What is the value of LoveFinderrz if it had no debt (i.e. its unlevered firm value)?
B) What is the value of LoveFinderrz with debt (i.e. its levered firm value)?
C) What is the market value of LoveFinderrz' equity?
D) What is the Weighted Average Cost of Capital (i.e. WACC) for LoveFinderrz?
Expert Solution
A) Computation of the value of unlevered firm:-
Value of unlevered firm = EBIT * (1 - Tax rate) / Unlevered cost of capital
= $11.36 * (1 - 37.5%) / 13.5%
= $52.593 billion
B) Computation of the value of levered firm:-
Value of levered firm = Value of unlevered firm + (Debt * Tax rate)
= $52.593 + ($68.19 * 37.5%)
= $52.593 + $25.571
= $78.164 billion
C) Computation of the market value of equity:-
Market value of equity = Value of levered firm - Debt
= $78.164 - $68.19
= $9.974 billion
D) Computation of the weighted average cost of capital (WACC):-
Value of levered firm = EBIT * (1 - Tax rate) / WACC
$78.164 = $11.36 * (1 - 37.5%) / WACC
WACC = $7.10 / $78.164
= 9.08%
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