Question

A local firm has debt worth $200,000, with a yield of 9%, and equity worth $300,000....

A local firm has debt worth $200,000, with a yield of 9%, and equity worth $300,000. It is growing at a 5% rate, and its tax rate is 40%. A similar firm with no debt has a cost of equity of 12%. Under the MM extension with growth, what is the value of your firm's tax shield, i.e., how much value does the use of debt add?

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Answer #1

Solution:- Given in Question-

Debt = $2,00,000

Yield = 9%

Equity Worth = $3,00,000

Growth Rate = 5%

Tax Rate = 40%

Firm has no debt has cost of equity = 12%

Total Value of Firm = $2,00,000 + $3,00,000 = $5,00,000

A Similar firm has no debt should have a Smaller Value.

To Calculate Firm Tax Shield-

Value Tax shelter =

Value Tax shelter =

Value Tax shelter = $1,02,857.14

Value of Firm which has no debt = Total Value - Value Tax shelter

Value of Firm which has no debt = $5,00,000 - $1,02,857.14

Value of Firm which has no debt = $3,97,142.86

If you have any query related to question then feel free to ask me in a comment. Thanks. Please rate.

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