Question

Best Foods, Inc. has an unlevered cost of capital of 10 percent. The company generates EBIT of $4,250 per year and has a tax rate of 35 percent. If the firm adds $10,000 of debt to its capital structure, what is the value of the levered firm?

Answer 1

Answer:

The value of the levered firm $31,125

Explanation:

Value of Firm is the value of present value of expected future earning. It is calculated by dividing the earning after tax by the cost of capital while considering that the business will operate for the foreseeable future time.

EBIT                      $4,250.00

Less

Interest                 $0.00        

EBT                       $4,250.00

Tax 35% x 4250  $1,487.50

EAT                       $2,762.50

Cost of Capial       10%

Value of firm = EAT / Cost of Capital = $2,762.5 / 10% = $27,625

Debt after tax = $10,000 x ( 1 - 0.35 ) = $6,500

Value of Equity = Value of firm - Debt after tax = $27,625 - $6,500 = $21,125

Value of debt = $10,000

Value of levered Firm = $21,125 + $10,000 = $31,125