Question

In: Finance

Assume the following data for two firms (U = unlevered firm) and (L = levered firm)....

Assume the following data for two firms (U = unlevered firm) and (L = levered firm). Assume the two firms are in the same risk class when it comes to business risk. Both firms have EBIT = €1000 000. Firm U has zero debt and its required rate of return (KsU = 12%). Firm L has €2000 000 debt and pays 10% interest rate.

Based on the data provided, answer the following questions and show all your computations and interpret your results.

Find the value of unlevered (U) and levered (L) firms under zero corporate tax assumption.
Find the market value of the firm’s L’s debt and equity.
Estimate the cost of capital and the WACC for the unlevered firm.
Do 1 and 2 under the assumption of corporate tax = 60%.

Solutions

Expert Solution

Where there is no tax

Where thare is no corporate tax , value of levered firm = value of unlevered firm

Value of unlevered form = EBIT/Required rate of return ( Since there is no tax PAT = EBIT)

= €1000 000/ 12%

= €8333333.33

Thus value of levered firm = €8333333.33

Value of equity + Value of debt = Value of firm

Thus €8333333.33 = Value of equity + €2000 000

Thus market value of equity of levered firm = €6333333.33

Market value of equity of levered firm = €2000 000

Where there Corporate tax = 60%

Value of unlevered firm = EBIT(1-tax rate)/Required rate of return

=€1000 000(1-60%)/12%

=€1000 000(0.4)/12%

= 40000/12%

=333333.33 €

Value of levered firm = Value of unlevered firm+ PV of interest shield

= 333333.33 € + (Loan amount x tax rate)

333333.33 € + (2000000 x 60%)

=333,333.33 + 1200,000

= 4533,333.33 €

Value of equity + Value of debt = Value of firm

Thus 4533,333.33 = Value of equity + €2000 000

Thus market value of equity of levered firm = €2533333.33

Market value of equity of levered firm = €2000 00

jeff jeffy answered 1 year ago

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