Tool Manufacturing has an expected EBIT of $63,000 in perpetuity and a tax rate of 35 percent. The firm has $170,000 in outstanding debt at an interest rate of 7.9 percent, and its unlevered cost of capital is 12 percent. What is the value of the firm according to MM Proposition I with taxes?

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abiolataiwo2015 abiolataiwo2015 · Answer 1 · 2020-12-06T02:06:09+01:00

Answer:

$400,750

Explanation:

Calculation for the value of the firm according to MM Proposition I with taxes

First step is to calculate the value of the unlevered firm using this formula

Value of the unlevered firm= EBIT(1 - Tax rate)/Unlevered cost of capital

Let plug in the formula

Value of the unlevered firm= ($63,000)(1 - 0.35)/0.12

Value of the unlevered firm=$63,000*0.65/0.12

Value of the unlevered firm=$40,950/0.12

Value of the unlevered firm= $341,250

Last step is to calculate the value of the levered firm using this formula

Value of the levered firm = Value of the unlevered firm+ (Tax rate*Outstanding debt)

Let plug in the formula

Value of the levered firm =$341,250 + 0.35($170,000)

Value of the levered firm=$341,250+59,500

Value of the levered firm = $400,750

Therefore the Value of the levered firm will be $400,750