Question

rmington company can borrow at 7.05 percent. the company currently has no debt and the cost of equity is 11.45 percent. the current value of the firm is $660,000. the corporate tax rate is 23 percent. what will the value be if the company borrows $375,000 and uses the proceeds to repurchase shares? note: do not round intermediate calculations and round your answer to the

Answer 1

The new value of Remington Company after borrowing $375,000 to repurchase shares, considering the 23% corporate tax rate, would be $746,250.

Step-by-step explanation:

When considering whether Remington Company should borrow $375,000 at 7.05 percent to repurchase shares, we need to calculate the new value of the firm using the Modigliani-Miller theorem with corporate taxes.

According to the Modigliani-Miller proposition, the value of a leveraged firm (VL) is equal to the value of an unleveraged firm (VU) plus the tax shield on debt.

Calculating the tax shield on debt at a 23 percent corporate tax rate, we get $86,250 which is the product of 23 percent tax rate and $375,000 debt.

Adding this to the initial value of the firm, the new value (VL) is $746,250.

To calculate this we use the formula:

VL = VU + (Corporate Tax Rate × Debt).

Thus, VL = $660,000 + (0.23 × $375,000)

= $660,000 + $86,250

= $746,250.

This calculation assumes the full tax shield is realized by the firm.