Question

Bassett Fruit Farm expects its EBIT to be $385,000 a year forever. Currently, the firm has no debt. The cost of equity is 13.5 percent and the tax rate is 34 percent. The company is in the process of issuing $2.5 million worth of bonds at par that carry an annual coupon of 6.3 percent. What is the unlevered value of the firm?

a. $2,411,790
b. $2,091,358
c. $1,882,222
d. $2,732,222
e. $1,694,000

Answer 1

The unlevered value of Bassett Fruit Farm, calculated using the formula VU = EBIT × (1 - Tax rate) / Cost of equity, is approximately $1,882,222.

Step-by-step explanation:

The value of Bassett Fruit Farm when it is unlevered, meaning entirely equity financed with no debt, can be calculated using the unlevered value of the firm formula:

VU = EBIT × (1 - Tax rate) / Cost of equity

For Bassett Fruit Farm, the EBIT is given as $385,000, the tax rate is 34%, and the cost of equity is 13.5%. Plugging in these numbers:

VU = $385,000 × (1 - 0.34) / 0.135

VU = $385,000 × 0.66 / 0.135

VU = $254,700 / 0.135

VU = $1,882,222 (approximately)

Therefore, the unlevered value of the firm is $1,882,222.