P16-14 M&M and Taxes [LO2] Frederick & Co. expects its EBIT to be $100,000 every
ID: 2645222 • Letter: P
Question
P16-14 M&M and Taxes [LO2]
Frederick & Co. expects its EBIT to be $100,000 every year forever. The firm can borrow at 9 percent. Frederick currently has no debt, and its cost of equity is 23 percent. If the tax rate is 33 percent, the value of the firm is $. The value will be $ if Frederick borrows $65,000 and uses the proceeds to repurchase shares. (Do not include the dollar signs ($). Round your answers to 2 decimal places. (e.g., 32.16))
Frederick & Co. expects its EBIT to be $100,000 every year forever. The firm can borrow at 9 percent. Frederick currently has no debt, and its cost of equity is 23 percent. If the tax rate is 33 percent, the value of the firm is $. The value will be $ if Frederick borrows $65,000 and uses the proceeds to repurchase shares. (Do not include the dollar signs ($). Round your answers to 2 decimal places. (e.g., 32.16))
Explanation / Answer
hi,
the correct answer is as follows:
If the tax rate is 33%, the value of the unlevered firm is:
VU = EBIT(1 - tC)/cost of equity
VU = $10000(1 - 0.33)/0.23
VU = $29130.43
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If Frederick borrows $65,000, the value of the levered firm is:
VU = VU + tCD
VU = $29130.43 + 0.33(65000)
VU = $50580.43
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