What will the value of the firm be if it converts to 50 percent debt?

Question

601 viewsOctober 22, 2016

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Darshita 6.14K October 22, 2016 0 Comments

New Schools, Inc. expects an EBIT of $7,000 every year forever. The firm currently has no debt, and its cost of equity is 17 percent. The firm can borrow at 8 percent and the corporate tax rate is 34 percent. What will the value of the firm be if it converts to 50 percent debt?

1 Answer

score 0 · Answer 1 · 2016-10-22T11:01:52+00:00

VU

= $7,000 (1 – 0.34)/0.17

= $27,176.47
VL

= $27,176.47 + 0.34 (0.50) ($27,176.47)

= $31,796.47
Note: When levered, the value of debt is equal to one-half of the unlevered value of the firm.

1 Answer

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