Tar Heel Healthcare has no debt financing and has a firm value of $20 million. I

Question

Tar Heel Healthcare has no debt financing and has a firm value of $20 million. It has a corporate tax rate of 34 percent. The firm's investors are estimated to have marginal tax rates of 31 percent on interest income and 28 percent on stock income. The firm is planning to change its capital structureby issuing $10 million in debt and repurchasing $10 million of common stock.

a) According to the MM view with corporate taxes, what is the value of the leveraged firm?

b) According to the Miller view with corporate and personal taxes, what is the gain from leverage?

Explanation / Answer

a) According to the MM view with corporate taxes, what is the value of the leveraged firm?

value of the leveraged firm = value of the unleveraged firm + Taxrate*debt

value of the leveraged firm = 20 + 34%*10

value of the leveraged firm = $ 23.40 Million

b) According to the Miller view with corporate and personal taxes, what is the gain from leverage?

Gain from leverage = (1- (1-34%)*(1-28%)/(1-31%))*10,000,000

Gain from leverage = $ 3,113,043.48

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