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