Neal Enterprises has no debt. Its current total value is $76.8 million. Assume d

Question

Neal Enterprises has no debt. Its current total value is $76.8 million. Assume debt proceeds are used to repurchase equity.

Ignoring taxes, what will the company’s value be if it sells $35.4 million in debt?

Requirement 2: Suppose now that the company’s tax rate is 35 percent. What will its overall value be if it sells $35.4 million in debt?

Ignoring taxes, what will the company’s value be if it sells $35.4 million in debt?

Requirement 2: Suppose now that the company’s tax rate is 35 percent. What will its overall value be if it sells $35.4 million in debt?

Explanation / Answer

Requirement 1

Here equity is simply replaced by debt and there is no tax shield so the value of the firm will remain the same.

Value of firm = 76.80 million

Requirement 2

Due to taxation, there is tax shield so the value of the firm will remain the same.

Value of firm = 76.80 million + 35.40 million x 0.35

                        = 89.19 million

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