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 $497,000 forever. The current cost of equity is 16% and the tax rate is 34%. The company is in the process of issuing $1.5 million of bonds at par that carry a 6% 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.)

A. $2.05 million B. $2.36 million C. $2.56 million D. $2.85 million According to the information from the question above, what is the levered value of the firm (in millions)? a. $2.05 million b. $2.36 million c. $2.56 million d. $2.85 million

Explanation / Answer

What is the unlevered value of the firm (in millions)

(pre-tax earnings)(1-corporate tax rate)] / the required rate of return = $497,000 (1 - 0.34) /16% = $2050125

i.e $2.05 million hence option A is correct.

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