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Continental Airlines once filed for bankruptcy, at least in part, as a means of reducing labor costs. Whether this move was ethical or proper was holtly debated. Give both sides of the argument.
Janetta Corp. has an EBIT Rate of $975,000 per year that is expected to continue in perpetuity. The unlevered cost of equity for the company is 14 percent, and the corporate tax rate is 35 percent. The company also has a perpetual bond issue outstanding with a market value of $1.9 million.
What is the value of the Compay?
The CFO of the company informs the company president that the value of the company is $4.8 million. Is the CFO Correct?
Tom Scott is the owner, president and primary sales person for scott manufacturing. Because of this, the company’s profits are driven by the amount of work Tom does. If he works 40 hours each week, the company’s EBIT will be $55,000 per year; if he works a 50 hour week, the company’s EBIT will be $625,000 per year.
The company is currently worth $3.2 million. The company needs a cash infusion of $1.3 million, and it can issue equity or issue debt with an interest rate of 8 percent. Assume there are no corporate taxes.
What are the cash flows to Tom under each scenario?
Under which form of financing is Tom likely to work harder?
What specific new costs will occur with each form of financing?
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