Question

The Eccles Inc., a zero growth firm, has an expected EBIT of $408,750 and a corporate tax rate of 30%. Eccles uses $400,000 of 12.0% debt, and the cost of equity to an unlevered firm in the same risk class is 16.0%. What is the value of the firm according to the MM model with corporate taxes?

Answer 1

Given,

EBIT = $408750

Tax rate = 30% or 0.30

Debt = $400000

Cost of debt = 12% or 0.12

Cost of equity = 16% or 0.16

Solution :-

Value of unlevered firm = [EBIT x (1 - tax rate)] cost of equity

= [$408750 x (1 - 0.30)] 0.16

= [$408750 x 0.70] 0.16

= $286125 0.16 = $1788281.25

Now,

Value of the firm = Value of unlevered firm + (debt x tax rate)

= $1788281.25 + ($400000 x 0.30)

= $1788281.25 + $120000 = $1908281.25