A company is an all-equity firm that has projected earnings before interest and

Question

A company is an all-equity firm that has projected earnings before interest and taxes (EBIT) of $500,000 forever. The current cost of equity rs=10% and the tax rate T=30%. The company is in the process of issuing $1.5 million of bonds at par that carry 6% annual coupon. What is the unlevered value of the firm ( in millions)? (Note: You should use MM capital structure model with corporate taxes, but without personal taxes and bankruptcy costs. The formula for the value of unlevered firm: Vu=EBIT x (1-T)/rs.

A. 2.05 MILLION

B. 2.23 MILLION

C. 2.85 MILLION

D. 3.50 MILLION

According to the information, what is the levered value of the firm (in millions)? (Note: The value of levered firm Vl=Vu+present value of annual interest tax shield)

A. 3.95 Million

B. 3.76 Million

C. 3.22 Million

D. 2.96 Million

Explanation / Answer

a> EBIT 500000 Earning after Income Tax=(1-0.3)*500000 350000 Value=350000/0.10 3500000 Ans : D ( 3.50 million) b> Interest=0.06*1500000 90000 Tax shield=90000*0.30 27000 PV of tax shield=27000/0.10 270000 Value=3500000+270000 3770000 Ans:B (3.76 million)

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