Given the following information,leverage will add how much value to the unlevered firm per pound of debt?
Corporate tax rate: 40%
Personal tax rate on income from bonds: 20%
Personal tax rate on income from shares: 30%
A)£-0.475
B)£0.475
C)£0.525
D)£0.633
E)None of the above.

Question

Quizplus · Accepted Answer

According to Modigliani-Miller theorem, in a perfect capital market, the value of a firm is independent of its capital structure. However, in the presence of taxes, leverage can provide benefits as interest payments are tax-deductible. The value of a levered firm can be calculated using the following formula:

VL = VU + (1 - Tc) * D

where VL is the value of the levered firm, VU is the value of the unlevered firm, Tc is the corporate tax rate, and D is the amount of debt.

To calculate the value that leverage adds per pound of debt, we need to find the difference between the value of the levered firm and the value of the unlevered firm and divide it by the amount of debt:

Value added per pound of debt = (VL - VU) / D

Substituting the given values, we get:

Value added per pound of debt = [(1 - 0.4) * D / (1 - 0.2)] - D
Value added per pound of debt = 0.475D

Therefore, leverage adds £0.475 to the value of the unlevered firm per pound of debt.

Given the Following Information,leverage Will Add How Much Value to the Unlevered