Final answer:
Under the Modigliani-Miller Theorem with a corporate tax rate of 20%, the value of Firm B with $400,000 debt is $880,000, accounting for the tax shield provided by debt.
Step-by-step explanation:
The question relates to the Modigliani-Miller Theorem, which in a frictionless world with certain assumptions (including no taxes or bankruptcy costs) states that the value of a leveraged firm (one with debt) should be equal to the value of an unleveraged firm (one with only equity). However, since the corporate tax rate is given as 20%, we must account for the tax shield benefit that debt provides.
Given that Firm A, which is all equity financed, is worth $800,000 and Firm B has outstanding debt of $400,000, we can calculate the value of Firm B by adding the tax shield benefit of the debt to the value of Firm A:
Value of Firm B = Value of Firm A + (Tax Rate × Debt)
Value of Firm B = $800,000 + (0.20 × $400,000)
Value of Firm B = $800,000 + $80,000
Value of Firm B = $880,000
Therefore, in a world that satisfies Modigliani-Miller assumptions with corporate taxes, the value of Firm B is $880,000.