Final answer:
The new value of Farmington Company after borrowing $375,000 to repurchase shares, factoring in the tax shield benefit on the debt at a corporate tax rate of 23%, would be $746,250.
Step-by-step explanation:
The value of Farmington Company if it borrows $375,000 to repurchase shares can be assessed using the Modigliani-Miller theorem on capital structure. The theorem posits that, in a perfect market, the value of the company is not affected by how the company is financed, whether through debt or equity. However, because interest is tax-deductible, there is a tax shield that increases the value of the firm when there is debt.
First, we need to calculate the tax shield on the debt. The tax shield is the corporate tax rate times the amount of debt, which can be expressed as:
Tax Shield = Corporate Tax Rate × Debt
Tax Shield = 0.23 × $375,000 = $86,250
Next, we calculate the new value of the firm by adding the tax shield to the initial value of the firm:
New Value of Firm = Initial Value of Firm + Tax Shield
New Value of Firm = $660,000 + $86,250 = $746,250
Therefore, the new value of Farmington Company after borrowing $375,000 to repurchase shares would be $746,250.