Final answer:
The value of an unlevered firm like Solid Rock is calculated by taking its EBIT, adjusting for taxes, and dividing by the cost of capital. In this case, the calculation results in a firm value of $50 million, which is answer B.
Step-by-step explanation:
The value of Solid Rock, an unlevered firm with an EBIT of $10 million and an unlevered cost of capital of 12 percent, can be determined using the formula for valuing an unlevered firm:
Value of the firm = EBIT × (1 - Tax Rate) / Cost of Capital
Substituting the given values:
Value of the firm = $10,000,000 × (1 - 0.40) / 0.12
Value of the firm = $10,000,000 × 0.60 / 0.12
Value of the firm = $6,000,000 / 0.12
Value of the firm = $50 million
The correct answer is B. $50 million, because after accounting for taxes, the firm's annual earnings are $6 million, and when divided by the cost of capital rate (12%), it results in a $50 million valuation for the firm.