Question

Tool Manufacturing has an expected EBIT of $57,000 in perpetuity and a tax rate of 21 percent. The firm has $134,000 in outstanding debt at an interest rate of 5.35 percent, and its unlevered cost of capital is 10.3 percent. What is the value of the firm according to M\&M Proposition I with taxes? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

The value of the firm according to M&M Proposition I with taxes is calculated by finding the after-tax EBIT, dividing it by the unlevered cost of capital to get the unlevered firm value, and then adding the tax shield from the debt. It results in a firm value of $465,518.64.

The value of the firm according to M&M Proposition I with taxes can be calculated by taking the expected EBIT and adjusting it for taxes, and then adding the tax shield benefit due to the debt. Here are the steps to calculate that value:

1. Determine the after-tax EBIT by subtracting taxes: EBIT(1-Tax rate).
2. Divide the after-tax EBIT by the unlevered cost of capital to find the unlevered value of the firm: Unlevered value = EBIT(1-Tax rate) / Unlevered cost of capital.
3. Calculate the tax shield by multiplying the debt with the tax rate: Tax shield = Debt * Tax rate.
4. Add the tax shield to the unlevered value of the firm to get the total value: Total value = Unlevered value + Tax shield.

Applying the given numbers:

1. EBIT(1-0.21) = $57,000 * (1-0.21) = $45,030
2. Unlevered value = $45,030 / 10.3% = $437,378.64
3. Tax shield = $134,000 * 21% = $28,140
4. Total value = $437,378.64 + $28,140 = $465,518.64

the value of the firm according to M&M Proposition I with taxes is $465,518.64.