Question

A firm has expected EBIT of $910, debt with a face and market value of $2,000 paying an 8.5% annual coupon, and an unlevered cost of capital of 12%. If the tax rate is 21%, what is the value of the equity

Answer 1

Answer: $4410

Explanation:

Firstly, the value of the levered firm will be:

= EBT( 1- Tax) / Unlevered cost of capital + Debt Value ( Tax Rate)

= 910(1 - 21%) / 12% + 2000(21%)

= 910( 1 - 0.21)/0.12 + 2000(0.21)

= 5990 + 420

= 6410

Then, the value of equity will be:

= VAlue of Firm - Value of Debt

= $6410 - $2000

= $4410