Suppose Luther Industries Is Considering Divesting One of Its Product

question 93

Essay

Suppose Luther Industries is considering divesting one of its product lines.The product line is expected to generate free cash flows of $2 million per year,growing at a rate of 3% per year.Luther has an equity cost of capital of 10%,a debt cost of capital of 7%,a marginal tax rate of 35%,and a debt-equity ratio of 2.If this product line is of average risk and Luther plans to maintain a constant debt-equity ratio,what after- tax amount must it receive for the product line in order for the divestiture to be profitable?

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Definitions:

Tenancy for Years

A leasehold interest in property for a definite period, which could be for any set length of time.

Implied Renewal Right

An implied renewal right is a legal principle that suggests a contract or agreement extends automatically beyond its original term unless one party gives notice to end it.

Personal Representative

Executors and administrators of wills in states that have adopted the Uniform Probate Code.

Probate Court

A specialized court that deals with matters concerning the distribution of deceased persons' estates.