A company is an all-equity firm that has projected earnings before interest and
ID: 2645812 • Letter: A
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 a 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).
$2.05 million
$2.23 million
$2.86 million
$3.50 million
According to the information from Question 9, 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)_______
$3.95 million
$3.76 million
$3.22 million
$2.96 million
$2.05 million
$2.23 million
$2.86 million
$3.50 million
According to the information from Question 9, 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)_______
$3.95 million
$3.76 million
$3.22 million
$2.96 million
Explanation / Answer
Answer :-
(Value of Unlevered Firm)
EBIT = $500000
Cost of Equity (Ke) = 10%
Tax Rate (T) = 30%
Value of Unlevered Firm = {EBIT *(1 - Tax Rate)} / Ke
= {500000 * (1 - 30%)} / 10%
= (500000 * .7) / .1
= 350000 / .1
= 3500000
= $3.5 million
(Value of Levered Firm)
Value of Debt. (D) = $1500000
Tax Rate (T) = 30%
Coupon Rate = 6%
Value of Levered Firm = Value of Unlevered Firm + (T * D)
( OR )
= Value of Unlevered Firm + Gain from leverage
= 3500000 + (30% * 1500000)
= 3500000 + (450000)
= 3950000
= $3.95 million
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