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elena-14-01-66
2 months ago
14

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
Business
1 answer:
Scilla [3.8K]2 months ago
7 0

Response:

The valuation of the levered firm amounts to $846,506

Details:

The valuation for the levered firm is derived from the total present value of future income expected by shareholders, calculated using the unlevered firm’s capital cost, and benefits from debt financing in terms of tax reductions.

Equity value is determined by the equation: Profit before tax * (1 - Tax) / Cost of capital

Tax benefits equal the product of debt value and tax rate

Substituting the known figures into the two equations yields:

Equity value = $138,000 (1 - 34%) / 13% = $669,706

The tax benefit from debt = $520,000 * 34% = $176,800

Thus, the value of the levered firm = $669,706 + $176,800 = $846,506

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