Question

Meyer & Co. expects its EBIT to be $97,000 every year forever. The firm can borrow at 8 percent. The company currently has no debt, and its cost of equity is 13 percent.

  

a.	If the tax rate is 24 percent, what is the value of the firm? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)
b.	What will the value be if the company borrows $195,000 and uses the proceeds to repurchase shares? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

a. Value of the firm

b. Value of the firm

Answer 1

a. Computation of value of the firm without debt (unlevered)

The value of Unlevered firm is:

EBIT (1 - tax rate) / cost of equity

= 97000 (1 - 0.24) / 0.13

= 97000 * 0.76 / 0.13

= 73720 / 0.13

= $567076.923

b. Computation of value if the company borrows $195,000 and uses the proceeds to repurchase the shares

The value of the levered firm is:

= Value of unlevered firm + Value of debt * tax rate

= 567076.9230 + 195000 * 0.24

= 567076.9230 + 46800

= $613876.923