Letang Corporation expects an EBIT of $22,250 every year forever. The company cu
ID: 2645303 • Letter: L
Question
Letang Corporation expects an EBIT of $22,250 every year forever. The company currently has no debt, and its cost of equity is 16 percent. The company can borrow at 9.5 percent and the corporate tax rate is 35.
What is the current value of the company? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)
(a) What will the value of the firm be if the company takes on debt equal to 60 percent of its unlevered value? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)
(b) What will the value of the firm be if the company takes on debt equal to 100 percent of its unlevered value? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)
(a) What will the value of the firm be if the company takes on debt equal to 60 percent of its levered value? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)
(b) What will the value of the firm be if the company takes on debt equal to 100 percent of its levered value? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)
Requirement 1:What is the current value of the company? (Do not round intermediate calculations. Round your answer to 2 decimal places (e.g., 32.16).)
Explanation / Answer
(1)
As per MM Theory we know that when there is coroporate tax is given
Value of Unlevered Firm ( all equity) = Value of levered firm + Tax Shield on DebtPaymnet
VU= VL+Interest (Tax Rate)
Vu= EBIT(1-Tax rate)/ Cost of Equity
Vu= 22250 (1-0.35)/0.16
Vu = $90390.62
(2)
Debt taken is 60 % of unlevered value
Hence debt= 90390.62*60%
Debt= 54234.37
We know that VL= VU+Tax Dhield on Debt
= 90390.62 + Debt *Tax rate
=90390.62+18982.02
VL= 109372.64
(3)
If debt is 100 % of unlevered value
VL= Vu + Tax Shield
VL= 90390.62+(90390.62*0.35)
VL= 90390.62+31636.71
VL= 122027.33
(4)
Debt is 60 % of levered value
We know that
VL= VU+Tax Dhield on Debt
VL= 90390.62+ (Debt * Tax Rate)
VL= 90390.62 + ( 0.6 *VL*0.35)
VL= 90390.62+ 0.21 VL
0.79 VL= 90390.62
VL= 90390.62/0.79
VL= $114418.51
(5)
If debt is 100 % of levered value
VL= 90390.62 + ( VL*0.35)
VL= 90390.62+0.35 VL
VL= 90390.62/0.65
VL= $139062.49
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