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Today, 08:31

The market value of Firm L's debt is $200,000 and its cost of debt is 7%. The firm's equity has a market value of $400,000, its earnings are growing at a 4% rate, and its tax rate is 40%. A similar firm with no debt has a cost of equity of 12%. Use the APV model to calculate the value of Firm L if it had no debt.

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  1. Today, 08:55
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    Answer: $530000

    Explanation:

    Debt $200000.

    Equity $400000

    rd=7%.

    rd for equity = 12%

    Taxrate = 40%

    Earning rate for equity = 4%

    Firm L has a total of $200000 + $400000 = $600000

    A similar firm with no debt should have a smaller value.

    The calculation is as follows.

    VTotal = Vu + Vts

    Make Vu the subject of the formula

    So,

    Vu = VTotal - Vts

    = Debt + Equity (S) - Vts

    Firstly, we need to calculate Vts

    Value tax shelter (Vts)

    =rdTD (rsU-G)

    = 0.07 (0.40) (200000) / (0.12-0.04)

    =5600/0.08

    = $80,000

    Therefore,

    Vu = $200000 + $400000 - $70000

    Vu = $600000 - $70000

    Vu = $ 530000

    In conclusion

    The value of Firm L if it has no debt is $530000
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Home » Business » The market value of Firm L's debt is $200,000 and its cost of debt is 7%. The firm's equity has a market value of $400,000, its earnings are growing at a 4% rate, and its tax rate is 40%. A similar firm with no debt has a cost of equity of 12%.
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