The firm is an all-equity firm with assets worth $500 million and 100 million shares outstanding. It plans to raise $200 million and use these funds to repurchase shares. The firm’s marginal corporate tax is 21%, and it plans to keep its outstanding debt equal to $200 million permanently. What is the value of equity for the leveraged firm? Assuming no financial distress or bankruptcy cost.
A) $542 million B) $458 million C) $342 million D) $300 million E) $158million
Value of all-Equity Firm(Unlevered Firm) = $500 million
Value of debt raised = $200
Calculating the Value of Unlevered Firm:-
VL = VU + {1-[(1-tc)/(1-tb)]}*Debt - C(B)
where, VL = value of Levered firm
VU = value of Unlevered firm = $500 million
tc = Corporate Tax Rate = 21%
tb = Personnel tax rate on Interest Income =0
C(B) = The Present value of Cost of Financial Distress = 0
VL = $500M + {1-[(1-0.21)/(1-0)]}*$200M - 0
VL = $500M + (1-0.79)*$200M
VL = $500M + $42M
So, Value of Levered Firm = $ 542 milllion
Value of equity of Leveraged Firm = Value of Levered Firm - Value of Debt
= $542 M - $200M
= $342 Million
So, Value of equity of Leveraged Firm is $ 342 million
Henec, Option C
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