Question

Arnold Co. has $200 billion of debt outstanding. An otherwise identical firm has no debt and has a market value of $700 billion. Under the Miller model, what is Arnold’s value if the federal-plus-state corporate tax rate is 25%, the effective personal tax rate on stock is 20%, and the personal tax rate on debt is 30%?

Answer 1

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Answer:

Since the identical unlevered firm has market value of $700 billion, so

Value of Cruz when debt free or unlevered = VU = $700 billion, Total debt of Cruz = D = $200 billion

Federal plus state corporate tax rate = Tc = 25%, Effective personal tax rate on stock = Ts = 20% and Effective personal tax rate on debt = Td = 30%

Since Cruz is a levered firm, using miller model we get

So Value of Cruz = Value of Levered firm = VU + [1- {(1-Tc)(1-Ts) / (1-Td)}] x D = 700 + [1- {(1-25%)(1-20%) / (1-30%)}] x 200

= 728.57 billion