- Old School Corporation expects an EBIT of $9,000 every year forever. Old School currently has no debt, and its cost of equity is 17 percent. The firm can borrow at 10 percent. If the corporate tax rate is 35 percent, what is the value of the firm? What will the value be if Old School converts to 50 percent debt? To 100 percent debt?
With no debt, we are finding the value of an unlevered firm, so:
V = EBIT(1 – tC)/RU
V = $9,000(1 – .35)/.17
V = $34,411.76
With debt, we simply need to use the equation for the value of a levered firm. With 50 percent debt, one-half of the firm value is debt, so the value of the levered firm is:
V = VU + tCD
V = $34,411.76 + .35($34,411.76/2)
V = $40,433.82
And with 100 percent debt, the value of the firm is:
V = VU + tCD
V = $34,411.76 + .35($34,411.76)
V = $46,455.88
