Question

Please show all work in excelGreat Lakes Shipping is an all-equity firm with anticipated earnings before interest and taxes of $439,000 annually forever. The present cost of equity is 16.4 percent. Currently, the firm has no debt but is considering borrowing $1.25 million at 8.5 percent interest. The tax rate is 36 percent. What is the value of the levered firm?$2,163,171$2,818,181$2,406,519$2,666,667$2,588,547

Answer 1

$2,163,171

Step-by-step explanation:

We use the MM model with taxes to evaluate a firm with financial leverage

`V_l = V_u + t * D\\$Where:\\V_l = $value of the levered firm\\Vu = value of unlevered firm\\D = debt of thee firm\\t = tax rate`

D x t = 1,250,000 x 0.36 = 450,000

Now we calcualte the value of the firm without financial leverage:

The unlevered firm will produce 439,000

It pays taxes for 36% and no interest expense so his net income will be

439,000 x ( 1 - 0.36) = 280,96‬0

then we calculate using the cost of equity the value of the firm usng the perpetuity formula:

280,960/.164 = 1,713,170.73 = 1,713,171

Now we add the debt tax shield to calculate the firm value with leverage

1,713,171 + 450,000 = 2,163,171