Mojito Mint Company has a debt-to-equity ratio of 23.The required return on the firm’s
unlevered equity is 16 percent, and the pretax cost of the firm’s debt is 10 percent. Sales revenue
or Mojito is expected to remain stable indefinitely at last year’s level of $19,740,000
Variable costs amount to 60 percent of sales. Mojito is taxed at the corporate tax rate of
40 percent.The firm distributes all of its earnings as dividends at the end of each year.
a. If Mojito were financed entirely by equity, how much would it be worth?

b. What is the required return on the firm’s levered equity (rS)?

c. Use the weighted-average-cost-of-capital method to calculate the value of Mojito Mint.
What is the value of the firm’s equity? What is the value of the firm’s debt?

d. Don’t worry about this.

Hints:
Part A – You should know how to do this by now. This is present value.

Part B- You’re solving for Rs.

rS = r0 + (B/S)(r0 – rB)(1 – TC)

r0 = the required return on the equity of an unlevered firm
rS        = the required return on the equity of a levered firm
rB        = the pre-tax cost of debt
TC    = the corporate tax rate
B/S = the firm’s debt-to-equity ratio

Part C –   B / (B+S)       = the firm’s debt-to-value ratio   = 2/5
S / (B+S) = the firm’s equity-to-value ratio = 3/5