New Schools, Inc. expects an EBIT of $7,000 every year forever. The firm currently has no debt, and its cost of equity is 17 percent. The firm can borrow at 8 percent and the corporate tax rate is 34 percent. What will the value of the firm be if it converts to 50 percent debt?
A)$29,871.17
B)$31,796.47
C)$32,407.16
D)$34,552.08
E)$37,119.30

Question

Quizplus · Accepted Answer

V_U = $7,000 (1 - 0.34)/0.17 = $27,176.47V_L = $27,176.47 + 0.34 (0.50) ($27,176.47) = $31,796.47Note: When levered, the value of debt is equal to one-half of the unlevered value of the firm.