Question

Hanover Tech is currently an all-equity company that has 145,000 shares of stock outstanding with a market price of $22 a share. The current cost of equity is 13.9 percent and the tax rate is 21 percent. The company is considering adding $1.5 million of debt with a coupon rate of 7.5 percent to its capital structure. The debt will be sold at par value. What is the levered value of the equity? Multiple Choice $2.209 million $2.012 million $2.108 million $2.005 million

Answer 1

Answer:

The correct answer is $2.005 million.

Explanation:

According to the scenario, the given data are as follows:

Outstanding shares = 145,000

Market price = $22 per share

Debt = $1.5 million

Tax rate = 21%

So, Equity = 145,000 × $22 = $3,190,000

Debt = $1,500,000 × 21% = $315,000

So, Value = Equity + debt

= $3,190,000 + $315,000

= $3,505,000

So, we can calculate levered value of equity by following formula:

Levered value of equity = Total value - debt

= $3,505,000 - $1,500,000

= $2,005,000