A company is an all-equity firm that has projected earnings before interest and

Question

A company is an all-equity firm that has projected earnings before interest and taxes (EBIT) of $500,000 forever. The current cost of equity is 10% and the tax rate is 30%. The company is in the process of issuing $2 million of bonds at par that carry a 5% annual coupon. What is the unlevered value of the firm (in millions)? (Note: You should use MM capital structure model with corporate taxes, but without personal taxes and bankruptcy costs.)

$3.05 million

$4.10 million

$5.35 million

$6.85 million

$3.50 million

$2.80million

$5.00 million

$6.50 million

According to the above information, what is the levered value of the firm (in millions)?_______

$3.05 million

$4.10 million

$5.35 million

$6.85 million

Explanation / Answer

(pre-tax earnings)(1-corporate tax rate)] / the required rate of return = $500,000 (1 - 0.30) /10% = $350000

i.e $3.50 million hence option A is correct.

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