Question

Stevenson's Bakery is an all-equity firm that has projected perpetual earnings before interest and taxes of $138,000 a year. The cost of equity is 13.7 percent and the tax rate is 32 percent. The firm can borrow money at 6.75 percent. Currently, the firm is considering converting to a debt-equity ratio of 0.45. What is the firm's levered value

Answer 1

Answer:

firm levered value is $752985

Explanation:

given data

earning = $138000

cost of equity = 13.7%

tax rate = 32 %

borrow money = 6.75 %

debt-equity ratio = 0.45

to find out

firm's levered value

solution

we know firm levered value is express as

firm levered value = current value + debt value × tax rate   ........1

here current value = earning (1 - tax rate ) / cost of equity

current value = 138000 (1 - 0.32 ) / 0.137

current value = $684963

and

debt value = current value × debt-equity ratio / ( 1+ debt-equity ratio)

debt value = 684963 × 0.45 / ( 1.45)

debt value = $212571

so from equation 1

firm levered value = current value + debt value × tax rate

firm levered value = 684963 + 212571 × 0.32

firm levered value = 684963 + 212571 × 0.32

firm levered value is $752985