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
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
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