New School Inc. expects an EBIT of $7,000 every year forever. The firm currently has no debt, and its cost of equity is 15 percent. The firm can borrow at 8 percent and the corporate tax rate is 34 percent. What will the value of the firm be if it converts to 50 percent debt?

Question

Business

Misael

28 October, 16:36

New School Inc. expects an EBIT of $7,000 every year forever. The firm currently has no debt, and its cost of equity is 15 percent. The firm can borrow at 8 percent and the corporate tax rate is 34 percent. What will the value of the firm be if it converts to 50 percent debt?

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Kael Moore · Answer 1

The value of firm is $32,032

Explanation:

Unlevered Value is the value of firm calculated purely on the equity portion of fund. Levered value is the value which includes the value of loan in it.

As per given data

EBIT = $7,000

Net Income = $7000 x (1 - 0.34) = $4,620

Unlevered value of the firm = $4,620 / 15% = $30,800

As given debt portion is 50%

Levered value of the firm = $30,800 + 8% x 50% x 30,800 = $30,800 + $1,232 = $32,032