The Ensyder Nursing Home (ENH) is a zero growth firm with an EBIT of $250,000 an

Question

The Ensyder Nursing Home (ENH) is a zero growth firm with an EBIT of $250,000 and a corporate tax rate of 40 percent. ENH uses $1 million of debt financing, and the cost of equity of an unleveraged firm in the same risk class is 15 percent. The personal tax rates of ENH's investors are 30 percent on interest income and 20 percent (on average) on income from common stocks.

a. What is the value of ENH according to MM with corporate taxes?

b. What is ENH's value according to Miller (including personal taxes)?

c. Suppose that the present value of financial distress costs is estimated to be $800,000, and that at a debt level of $1 million, ENH has a 20 percent probability of going bankrupt. What is the firm's value if these costs are added to the Miller model?

Explanation / Answer

As per MM approach there are some assumption like:

(a) Value of Firm as per MM approach with corporate tax: value of firm = profit available to equity sharehoder / cost of equity

= 250000(1 - .40) / .15

=1000000

(b)Value of Firm as per MM approach with personal tax: As mentioned in the assumption ther will be no personal tax . So the value of firm in this will also be same as in (a)

Value of firm = 1000000

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