 Business
4 June, 01:46

# An unlevered firm has a cost of capital of 13.6 percent and earnings before interest and taxes of \$138,000. A levered firm with the same operations and assets has both a book value and a face value of debt of \$520,000 with an annual coupon of 7 percent. The applicable tax rate is 34 percent. What is the value of the levered firm

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Answers (1)
1. 4 June, 02:13
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Value of levered firm is \$846,506

Explanation:

The value of levered firm will be the sum of value of the future incomes for the shareholder's at the cost of capital of un-levered firm discounted at cost of equity and the tax advantage of debt.

The value of equity = Profit before tax * (1 - Tax) / Cost of capital

The tax advantage = Value of debt * tax rate

Now putting the values in both above equation:

Value of equity = \$138,000 (1 - 34%) / 13% = \$6,69,706

The tax advantage of Debt = \$520,000 * 34% = \$176,800

Value of levered firm = \$669,706 + \$176,800 = \$846,506
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