Question

A company with 100% equity financing decides to refinance with 50% equity and 50% debt financing....

A company with 100% equity financing decides to refinance with 50% equity and 50% debt financing.

If the unleveraged value of the firm is $100 million, the firm is subject to a corporate tax rate of 40%, and the average investor in the firm is subject to a 40% tax rate on interest and a 20% tax rate on equity income, according to the MM model with corporate taxes and personal taxes, what is the new leverage value of the firm? Do NOT include commas in your numerical response.

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Answer #1

According to MM model-III (with corporate taxes and personal taxes), value of leverage firm can be computed with following equation:

where,

VL = Value of leverage firm

VU = Value of unleverage firm

tc = Corporate tax rate

ts = tax rate on equity income

td = tax rate on interest income

D = Debt

Putting the values:

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