Letang Corporation expects an EBIT of $20,000 every year forever. The company cu
ID: 2719750 • Letter: L
Question
Letang Corporation expects an EBIT of $20,000 every year forever. The company currently has no debt, and its cost of equity is 14.5 percent. The company can borrow at 9 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).)
Letang Corporation expects an EBIT of $20,000 every year forever. The company currently has no debt, and its cost of equity is 14.5 percent. The company can borrow at 9 percent and the corporate tax rate is 35.
Explanation / Answer
Requirement 1:
As per the M & M capital structure model with taxes, the value of the firm: Currently the company is having no debt and is unlevered
Vul = {EBIT *(1 - Tax)}/ ke
= {20000*(1- 0.35)}/ 0.145
= { 20000* 0.65} / 0.145
= 13000/0.145
Value of the firm Vul = 89655.17 $
Requirement 2:
2. a. The value of the firm if it takes debt equal to 60% of its unlevered value.
Debt D = 0.60 * 89655.17 = 53793.102 $
The company is now a levered firm and value of the firm as per the M & M model:
Vl = Vul + (D * Tax)
= 89655.17 + (53793.102* 0.35)
= 89655.17 + 18827.5857
= 108482.7557 $
Value of levered firm Vl = 108482.75 $
2.b
The value of the firm if it takes debt equal to 100% of its unlevered value.
Debt D = 89655.17 $
The company is now a levered firm and value of the firm as per the M & M model:
Vl = Vul + (D * Tax)
= 89655.17 + (89655.17* 0.35)
= 89655.17 + 31379.3095
= 121034.4795 $
Value of levered firm Vl = 121034.48 $
Requirement 3: a.
The value of the firm if it takes debt equal to 60% of its levered value.
Debt D = 0.60 * Vl $
The company is now a levered firm and value of the firm as per the M & M model:
Vl = Vul + (D * Tax)
Vl = 89655.17 + (Vl *0.6 * 0.35)
Vl = 89655.17 + 0.21Vl
0.79 Vl = 89655.17
Vl = 113487.5569620253 $
Value of levered firm Vl= 113487.56 $
3.b. The value of the firm if it takes debt equal to 100% of its levered value.
Debt D = 1.00 * Vl
The company is now a levered firm and value of the firm as per the M & M model:
Vl = Vul + (D * Tax)
Vl = 89655.17 + (Vl * 0.35)
0.65 Vl = 89655.17
Vl = 137931.0307692308 $
Value of levered firm Vl = 137931.03 $
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