If the value of a levered firm is $4,000,000,then the value of the same firm all-equity-financed is:
A) $3,000,000.
B) $4,500,000.
C) $5,500,000.
D) $6,000,000.

Question

Quizplus · Accepted Answer

The value of a levered firm incorporates both debt and equity components. The value of the firm without any debt financing is known as the unlevered value or the value of the firm's assets. It is calculated as the sum of the present value of future cash flows generated by the assets discounted at the unlevered cost of capital. In this case, since the value of the levered firm is given as $4,000,000, it represents the total value of the firm including its debt and equity components.

If the same firm were to be financed with all equity, then it becomes an unlevered firm, and its value would equal the unlevered value of the firm's assets. Since the value of the levered firm is given as $4,000,000, this includes the value of the debt component as well. Hence, to find the value of the all-equity-financed firm, we need to subtract the value of debt from the total value of the firm.

Thus, the value of the all-equity-financed firm can be calculated as:

Value of unlevered firm = Value of levered firm - Value of debt

Assuming that the value of debt is $1,000,000, we get:

Value of unlevered firm = $4,000,000 - $1,000,000 = $3,000,000

Therefore, the correct answer is A) $3,000,000.

If the Value of a Levered Firm Is $4,000,000,then the Value