Blue Berry (BB) will remain in business for one more year. At the end of next ye

Question

Blue Berry (BB) will remain in business for one more year. At the end of next year, the firm will generate a liquidating cash flow of $230M in a boom year and $100M in a recession year; both states are equally likely. The firm’s outstanding debt matures in a year, has a market (and book) value of $100M and a yield to maturity of 15%. The cost of equity for the unlevered firm is rU = 10%. Corporate taxes is the only market imperfection.

If the present value of the interest tax shield is $1.4M, the value of the equity must be:

(A) $ 45.45M

(B) $ 48.00M

(C) $ 50.00M

(D) $ 51.40M

Explanation / Answer

Answer: expected value of the liquiditating cash : probability * cash flow

0.5* 230 + 0.5 * 100 = $165 million

Outstanding debt company has to pay in the coming year along with coupon money = $100 million + $100*15%

100 + 100*0.15 = $115 million

equity value of the company( for next year) = total value - debt need to pay

equity value = 165 - 115 = 50 million

discount it to get the present value = 50/(1 + interest rate) = 50/1.1 = $45.45 Million option A is the answer

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