Question

Meyer & Co. expects its EBIT to be $111,000 every year forever. The firm can borrow at 6 percent. T

he company currently has no debt, and its cost of equity is 13 percent.

a. If the tax rate is 25 percent, what is the value of the firm? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

b. What will the value be if the company borrows $235,000 and uses the proceeds to repurchase shares? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

a. $640,384.62

b. $699,134.62

Step-by-step explanation:

a. The computation of the value of the firm is shown below:

= EBIT × ( 1 - tax rate) ÷ cost of equity

= $111,000 × ( 1 - 0.25) ÷ 13%

= $83,250 ÷ 13%

= $640,384.62

b. The computation of the value of the firm in second case is shown below:

= Value of the firm + borrowed amount × tax rate

= $640,384.62 + $235,000 × 25%

= $640,384.62 + $58,750

= $699,134.62