Question

A firm with no debt has 200,000 shares outstanding valued at $20 each. Its cost of equity is 12%. The firm is considering adding $1 million in debt to its capital structure. The coupon rate would be 8% and the bonds would sell for par value. The firm's tax rate is 34%. How much will the firm be worth after adding the debt? A) $4.033 million B) $4.180 million C) $4.340 million D) $4.660 million E) $5.000 million

Answer 1

Option (C) is correct.

Step-by-step explanation:

Given that,

No. of shares = 200,000

Market value per share = $20 each

Tax rate = 34%

Debt amount = $1,000,000

Market value of firm:

= Market value of equity + (Tax rate × Debt)

= (No. of shares × market value per share) + (Tax rate × Debt amount)

= (200,000 × $20) + (0.34 × $1,000,000)

= $4,000,000 + $340,000

= $4,340,000

= $4.340 million

The firm be worth after adding the debt is $4.340 million.