Ask Question
25 May, 17:37

The market value of Firm L's debt is $200,000 and its cost of debt is 7%. The firm's equity has a market value of $400,000, its earnings are growing at a 4% rate, and its tax rate is 40%. A similar firm with no debt has a cost of equity of 12%. Use the APV model to calculate the value of Firm L if it had no debt.

+4
Answers (1)
  1. 25 May, 18:56
    0
    Answer: $530000

    Explanation:

    Debt $200000.

    Equity $400000

    rd=7%.

    rd for equity = 12%

    Taxrate = 40%

    Earning rate for equity = 4%

    Firm L has a total of $200000 + $400000 = $600000

    A similar firm with no debt should have a smaller value.

    The calculation is as follows.

    VTotal = Vu + Vts

    Make Vu the subject of the formula

    So,

    Vu = VTotal - Vts

    = Debt + Equity (S) - Vts

    Firstly, we need to calculate Vts

    Value tax shelter (Vts)

    =rdTD (rsU-G)

    = 0.07 (0.40) (200000) / (0.12-0.04)

    =5600/0.08

    = $80,000

    Therefore,

    Vu = $200000 + $400000 - $70000

    Vu = $600000 - $70000

    Vu = $ 530000

    In conclusion

    The value of Firm L if it has no debt is $530000
Know the Answer?
Not Sure About the Answer?
Find an answer to your question ✅ “The market value of Firm L's debt is $200,000 and its cost of debt is 7%. The firm's equity has a market value of $400,000, its earnings ...” in 📘 Business if you're in doubt about the correctness of the answers or there's no answer, then try to use the smart search and find answers to the similar questions.
Search for Other Answers