Stevenson's Bakery is an all-equity firm that has projected perpetual EBIT of $198,000 per year. The...

Stevenson's Bakery is an all-equity firm that has projected perpetual EBIT of $198,000 per year. The cost of equity is 14.1 percent and the tax rate is 34 percent. The firm can borrow perpetual debt at 5.8 percent. Currently, the firm is considering converting to a debt–equity ratio of 1.08. What is the firm's levered value?

Expert Solution

Given that

EBIT = $198,000
Cost of Equity = 14.1%
Tax Rate = 34%

Based on the above information, the computation of the firm levered value is shown below:

But before that first find the value of unlevered firm

Value of Unlevered Firm = EBIT * (1 - tax) / (Cost of Equity)
= $198,000 * (1 - 0.34) / 0.141
= $926,808.51

Now Debt-equity Ratio is 1.08

So,

Value of Debt = Weight of Debt * Value of Unlevered Firm
= (1.08/2.08) * $926,808.51
= $481,228

Now

Value of Levered Firm = Value of Unlevered Firm + tax * Value of Debt
= $926,808.51+ 0.34 * $481,228
= $1,090,426

jeff jeffy answered 2 years ago

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