O’Connell & Co. expects its EBIT to be $87,000 every year forever. The firm can
ID: 2741897 • Letter: O
Question
O’Connell & Co. expects its EBIT to be $87,000 every year forever. The firm can borrow at 12 percent. O’Connell currently has no debt, and its cost of equity is 16 percent.
If the tax rate is 35 percent, what is the value of the firm? (Round your answer to 2 decimal places. (e.g., 32.16))
What will the value be if the company borrows $160,000 and uses the proceeds to repurchase shares? (Round your answer to 2 decimal places. (e.g., 32.16))
If the tax rate is 35 percent, what is the value of the firm? (Round your answer to 2 decimal places. (e.g., 32.16))
Explanation / Answer
1) If the tax rate is 35 percent, The value of firm having no debt :-
Value of firm = EBIT (1 - Tax rate) / Cost of equity
= 87000 * (1 - 0.35) / 0.16
= 56550 / 0.16
= $ 353437.50
2) Tha value of firm if the company borrows $160,000 and uses the proceeds to repurchase shares:-
Value of firm = Value of Unlevered firm (Equity only) + Debt * Tax rate
= 353437.50 + 160000 * 0.35
= 353437.50 + 56000
= $ 409437.50
Conclusion:-
Particulars Amount (In dollars) 1) The value of firm having no debt:- 353437.50 2) Tha value of firm if the company borrows $160,000 and uses the proceeds to repurchase shares:- 409437.50Related Questions
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