Question

Stevenson's bakery is an all-equity firm that has projected perpetual ebit of $192,000 per year. The cost of equity is 13.7 percent and the tax rate is 39 percent. the firm can borrow perpetual debt at 6 percent. Currently, the firm is considering taking on debt equal to 102 percent of its unlevered value. What is the firm's levered value?

o $1,024,928
o $854,891
o $1,194,966
o $1,286,886
o $769,401

Answer 1

The levered value of Stevenson's bakery is approximately $1,194,966, calculated using the Modigliani-Miller Proposition I with corporate taxes and the given financial variables.

Step-by-step explanation:

The levered value of Stevenson's bakery can be calculated using the Modigliani-Miller Proposition I with corporate taxes. The formula for the levered value (VL) is VU + (TC × D), where VU is the unlevered value of the firm, TC is the corporate tax rate, and D is the amount of debt.

First, we find the unlevered value of the firm (VU) using the formula VU = EBIT × (1 - TC) / Re, where EBIT is the earnings before interest and taxes, TC is the tax rate, and Re is the cost of equity. Plugging in the given numbers:

VU = $192,000 × (1 - 0.39) / 0.137 = $842,219 (approximately)

Now, to calculate the levered value, we need the amount of debt the firm is taking on. Given that the firm will take on debt equal to 102% of its unlevered value:

D = 102% of VU = 1.02 × $842,219 = $859,063 (approximately)

Using the formula for levered value VL = VU + (0.39 × D), we calculate:

VL = $842,219 + (0.39 × $859,063) = $1,194,966 (approximately)

This means the levered value of Stevenson's bakery is roughly $1,194,966.