Levered, Inc., and Unlevered, Inc., are identical in every way except their capital structures. Each company...

Levered, Inc., and Unlevered, Inc., are identical in every way except their capital structures. Each company expects to earn $29.3 million before interest per year in perpetuity, with each company distributing all its earnings as dividends. Levered’s perpetual debt has a market value of $94 million and costs 8 percent per year. Levered has 2.6 million shares outstanding, currently worth $108 per share. Unlevered has no debt and 4.8 million shares outstanding, currently worth $83 per share. Neither firm pays taxes.

a. What is the value of each firm? (Enter your answers in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answers to the nearest whole number, e.g., 32.)

	Value of the firm
Unlevered	$
Levered	$

b. Are these answers what you would expect?

	Yes
	No

Solutions

Expert Solution

Value of the Firm

Levered Firm contains mixture of Debt and Equity in its capital structure. However, An unlevered Firm is only financed by equity.

Thus,

	Calculation	Value of Firm
Levered Inc.	94,000,000 + (2,600,000*108)	$ 374,800,000
Unlevered Inc.	4,800,000*83	$ 398,400,00

Please note - Value of Firm can also be calculated with company's Earning but for this we need required rate of return (WACC). Answer would be same because question already provided market value of debt and equity and it is in equilibruim.

Please refer below spreadsheet for calculation of value of firm using WACC . Formula reference also provided for better understanding.

Formula reference -

We can see in above sheet , value of firm is same.

Hope this will help, if you need any further clarification please comment.

jeff jeffy answered 1 year ago

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