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1 December, 18:16

Stevenson's Bakery is an all-equity firm that has projected perpetual earnings before interest and taxes of $138,000 a year. The cost of equity is 13.7 percent and the tax rate is 32 percent. The firm can borrow money at 6.75 percent. Currently, the firm is considering converting to a debt-equity ratio of 0.45. What is the firm's levered value

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  1. 1 December, 18:36
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    firm levered value is $752985

    Explanation:

    given data

    earning = $138000

    cost of equity = 13.7%

    tax rate = 32 %

    borrow money = 6.75 %

    debt-equity ratio = 0.45

    to find out

    firm's levered value

    solution

    we know firm levered value is express as

    firm levered value = current value + debt value * tax rate ... 1

    here current value = earning (1 - tax rate) / cost of equity

    current value = 138000 (1 - 0.32) / 0.137

    current value = $684963

    and

    debt value = current value * debt-equity ratio / (1 + debt-equity ratio)

    debt value = 684963 * 0.45 / (1.45)

    debt value = $212571

    so from equation 1

    firm levered value = current value + debt value * tax rate

    firm levered value = 684963 + 212571 * 0.32

    firm levered value = 684963 + 212571 * 0.32

    firm levered value is $752985
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