Compressed APV Model with Constant Growth An unlevered firm has a value of $750

Question

Compressed APV Model with Constant Growth

An unlevered firm has a value of $750 million. An otherwise identical but levered firm has $40 million in debt at a 5% interest rate. Its cost of debt is 5% and its unlevered cost of equity is 12%. After Year 1, free cash flows and tax savings are expected to grow at a constant rate of 4%. Assuming the corporate tax rate is 40%, use the compressed adjusted present value model to determine the value of the levered firm. (Hint: The interest expense at Year 1 is based on the current level of debt.) Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Do not round intermediate calculations. Round your answer to two decimal places.

$   million

Explanation / Answer

Value of levered firm = Value of unlevered firm +(Corporate Tax rate*Value of debt) 750 +(0.40*40) 750 + 16 766 Value of Levered firm is $ 766 million

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