Problem 21-4 APV Model with Constant Growth An unlevered firm has a value of $90

Question

Problem 21-4

APV Model with Constant Growth

An unlevered firm has a value of $900 million. An otherwise identical but levered firm has $70 million in debt at a 3% interest rate. Its cost of debt is 3% and its unlevered cost of equity is 11%. After Year 1, free cash flows and tax savings are expected to grow at a constant rate of 3%. Assuming the corporate tax rate is 35%, 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 Unleverged firm= next year cash flow/(cost of equity-growth rate)

$900 = Next year cashflow/ 8%

Next year cash flow= 900*.08= $72 million

Expected tax benefit from Debt= $70*35%= $24.50 million

Adjusted value of Firm= $900+$24.50= $924.50 Million

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