The Zercon Company has EBIT of $50,000 and market value debt of $100,000 outstanding with a 9% coupon rate. The cost of equity for an all equity firm would be 14%. Zercon has a 35% corporate tax rate. Investors face a 20% tax rate on debt receipts and a 15% rate on equity. Determine the value of Zercon.
A) $263,080.
B) $332,143.
C) $258,537.
D) $162,948.
E) $120,000.

Question

Quizplus · Accepted Answer

The correct answer is A. The value of Zercon is $263,080. This is calculated as follows:Value of Zercon = Value of Equity + Value of DebtValue of Equity = EBIT / (Cost of Equity * (1 - Tax Rate))Value of Equity = $50,000 / (0.14 * (1 - 0.35))Value of Equity = $50,000 / 0.091Value of Equity = $549,451Value of Debt = Market Value of Debt / (1 - Tax Rate)Value of Debt = $100,000 / (1 - 0.20)Value of Debt = $100,000 / 0.80Value of Debt = $125,000Value of Zercon = $549,451 + $125,000Value of Zercon = $263,080

The Zercon Company Has EBIT of $50,000 and Market Value