KD industries has 30 million shares outstanding with a market price of $20 per s

Question

KD industries has 30 million shares outstanding with a market price of $20 per share and no debt. KD has had consistently stable earnings, and pays a 35% tax rate. Management plans to borrow $200 million on a permanent basis through a leveraged recapitalization in which they would use the borrowed funds to repurchase outstanding shares. After the recapitalization, the value of KD's levered equity is closest to:

1) 670 million

2) 400 million

3) 330 million

4) 470 million

**** please show work ***

Explanation / Answer

value of unlevered firm = 20*300 = 600 million

value of tax shield due to use of debt = amount borrowed*tax rate

=200*35%= 70 million

value of levered firm = value of unlevered firm+tax shield

value of levered firm = 600+70 = 670 million

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