Question

Lazare Corporation expects an EBIT of $22,500 every year forever. Lazare currently has no debt, and its cost of equity is 12 percent. The firm can borrow at 7 percent. (Do not round intermediate calculations. Round the final answers to 2 decimal places.)

  

a.	What is the corporate tax rate is 35 percent, what is the value of the firm?

  

Value of the firm

$

     

b.	What will the value be if the company converts to 60 percent debt?

  

Value of the firm

$

  

c.	What will the value be if the company converts to 60 percent debt to 100 percent debt?

Answer 1

(a)      
Unlevered Free cash flow = EBIT*(1-tax Rate)      
22500*(1-35%)      
14625.0      
Enterprise value without leverage or Unlevered value= Unlevered Free cash flow/Unlevered cost of equity      
14625/12%=   121875.0  
Value of all Equity Firm is   $121,875.00  

(b)      
60% Debt of firm's value=      
121875*60%=   73125  
As per MM approach, if Debt is issued, Value of levered firm will be Value of unlevered firm increased by present value of interest tax shield      
Present value of interest tax shield = Present value of debt * tax rate      
73125*35%=   25593.75  
Value of levered firm = Value of unlevered Firm + PV of tax shield      
New value = 121875+25593.75=   147468.8  
      
      
So, value of firm is    $147,468.75  

(c) 100% debt=      
121875*100%=   121875  
Present value of interest tax shield = Present value of debt * tax rate      
121875*35%=   42656.25  
Value of levered firm = Value of unlevered Firm + PV of tax shield      
New value = 121875+42656.25=   164531.3  
      
So value of Firm is   $164,531.25