Question

The firm is an all-equity firm with assets worth $500 million and 100 million shares outstanding....

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

Homework Answers

Answer #1

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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