Discuss Modigliani and Miller's Propositions I in a world with corporate tax but no other market...

Discuss Modigliani and Miller's Propositions I in a world with corporate tax but no other market frictions nor distress costs. List the basic assumptions, results, and intuition of the model.

Based on this model, if the original unlevered firm value is $100 million, the corporate tax rate is 20%, and the CFO is planning to carry out a leveraged recapitalization to add a permanent debt of $30 million. The interest rate for the debt is 6% for the coming year. The unlevered equity requires 10% annual return. What’s the levered firm value? What’s the value of levered equity?

Expert Solution

If company takes debt, Value of firm will be Equal to Value of unlevered firm + PV of interest tax shield
Debt=   30000000
Tax rate=   20%
PV of interest tax shield = Debt*Tax rate
30000000*20%
6000000

Unlevered value of firm=    100000000
Levered Value of Firm= unlevered value of Firm + pV of interest tax shield
Levered Value of Firm =100000000 +6000000
106000000

Value of levered Equity = Levered value of Firm - debt Amount
106000000   -30000000
76000000

So Levered Value of Firm is   106000000
Levered Value of Equity is   76000000

jeff jeffy answered 4 months ago

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