Cede & Co. expects its EBIT to be $80,000 every year forever. The firm can borro

Question

Cede & Co. expects its EBIT to be $80,000 every year forever. The firm can borrow at 4 percent. The firm currently has no debt, and its cost of equity is 10 percent.

If the tax rate is 35 percent, what is the value of the firm? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Value of the firm $

What will the value be if the company borrows $122,000 and uses the proceeds to repurchase shares? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Value of the firm $

Explanation / Answer

Value of unlevered firm:

= $80,000*(1-35%)/10%

= $520,000

Value of levered firm:

= Value of unlevered firm+Debt*Tax rate

= $520,000+$122,000*35%

= $562,700

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