An unlevered firm currently has a value of $100 million.The firm has a tax rate of 30%.The firm wishes to replace $50 million of its equity with $50 million of permanent debt.What is the value of the levered firm if it goes ahead with this plan?
A)$115 million
B)$100 million
C)$50 million
D)$150 million
E)$85 million

Question

Quizplus · Accepted Answer

The value of the levered firm can be calculated using the Modigliani-Miller Proposition I with taxes. The value of the levered firm (V_L) equals the value of the unlevered firm (V_U) plus the tax shield on debt (T_C*D), where T_C is the corporate tax rate and D is the debt amount. Here, V_U = $100 million, T_C = 30%, and D = $50 million. The tax shield on debt is 0.30 * $50 million = $15 million. Therefore, V_L = $100 million + $15 million = $115 million.

An Unlevered Firm Currently Has a Value of $100 Million