. A firm with no debt financing has a firm value of $34 million. It has a corpor
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Question
. A firm with no debt financing has a firm value of $34 million. It has a corporate marginal tax rate of 38 percent. The firm’s investors are estimated to have marginal tax rates of 28 percent on interest income and a weighted average of 21 percent on stock income. The firm is planning to change its capital structure by issuing $7 million in debt, and repurchasing $7 million of common stock.
a. According to MM with corporate taxes, what is the value of the levered firm?
b. According to Miller with corporate and personal taxes, what is the value of the levered firm?
Explanation / Answer
A. Value of unlevered firm VU = $ 34 million
According to MM theory with only corporate taxes assuming perpetual debt, value of a levered firm
VL= VU+ TCx D
where TC and D are marginal corporate tax rate and debt to the firm respectively.
Threfore, VL = 34000000 + 0.38 x 7000000 = $ 36,660,000
With only corporate taxes, value of the levered firm is $ 36.66 million
B. Personal tax rate on interest income ti = 0.28
Personal tax rate on stock income ts = 0.21
As per Miller model, value of levered firm with personal taxes
V*L = VU + [1 – (1 – ti) (1 – TC)] / (1 – ts) x D
= 34,000,000 + [1 – (1 – 0.28) (1 – 0.38)] / (1 – 0.21) x 7,000,000 = $ 38,905,316
Therefore, corporate and personal taxes, value of the levered firm is $ 38,905,316
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