Bruce & Co. expects its EBIT to be $52,000 every year forever. The firm can borr

Question

Bruce & Co. expects its EBIT to be $52,000 every year forever. The firm can borrow at 9 percent. Bruce currently has no debt, and its cost of equity is 12 percent.

If the tax rate is 35 percent, what is the value of the firm? (Do not round intermediate calculations and round your answer to 2 decimal places. (e.g., 32.16))

What will the value be if Bruce borrows $129,000 and uses the proceeds to repurchase shares? (Do not round intermediate calculations and round your answer to 2 decimal places. (e.g., 32.16))

Bruce & Co. expects its EBIT to be $52,000 every year forever. The firm can borrow at 9 percent. Bruce currently has no debt, and its cost of equity is 12 percent.

Explanation / Answer

a.     The value of the unlevered firm is:

         V = EBIT(1 – tC)/RU

         V = $52,000(1 – 0.35) / 0.12

         V = $281,666.67

b.    The value of the levered firm is:

         V = VU + tCD

         V = $281,666.67 + 0.35($129,000)

                        V = $326,816.67

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