Question

An unlevered firm has a cost of capital of 16% and earnings before interest and taxes...

An unlevered firm has a cost of capital of 16% and earnings before interest and taxes of $225,000. A levered firm with the same operations and assets has both a book value and a face value of debt of $850,000 with an 8% annual coupon. Assume no taxes, no bankruptcy. What is the value of equity for the levered firm?

Select one:

A. 624,250

B. 556,250

C. 850,000

D. 556,250

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Homework Answers

Answer #1

Answer is $556,250

Earnings before Interest and Taxes = $225,000
Unlevered Cost of Capital = 16%

Value of Unlevered Firm = Earnings before Interest and Taxes / Unlevered Cost of Capital
Value of Unlevered Firm = $225,000 / 0.16
Value of Unlevered Firm = $1,406,250

Value of Levered Firm = Value of Unlevered Firm
Value of Levered Firm = $1,406,250

Value of Equity = Value of Levered Firm - Value of Debt
Value of Equity = $1,406,250 - $850,000
Value of Equity = $556,250

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