Levered, Inc., and Unlevered, Inc., are identical in every way except their capi

Question

Levered, Inc., and Unlevered, Inc., are identical in every way except their capital structures. Each company expects to earn $28.1 million before interest per year in perpetuity, with each company distributing all its earnings as dividends. Levered’s perpetual debt has a market value of $82 million and costs 9 percent per year. Levered has 1.4 million shares outstanding, currently worth $124 per share. Unlevered has no debt and 3.6 million shares outstanding, currently worth $70 per share. Neither firm pays taxes.

What is the value of each firm?

Unlevered $

Levered $

Explanation / Answer

Value of unlevered firm = Number of share outstanding × current stock price

= 3.60 million × $70

= $252 million.

Value of unlevered firm is $252 million.

b.

Value of levered firm = (Number of share outstanding × current stock price) + Value of debt

= (1.40 million × $124) + $82 million

= $173.60 million + $82 million

= $255.60 million.

Value of levered firm is $255.60 million.

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