Question

Kline Construction is an all-equity firm that has projected perpetual earnings before interest and taxes of $879,000. The current cost of equity is 18.3 percent and the tax rate is 34 percent. The company is in the process of issuing $6.2 million of 8.5 percent annual coupon bonds at par. What is the levered value of the firm?

A. $5,278,164

B. $5,541,085

C. $6,422,225

D. $6,713,185

E. $7,385,695

Answer 1

The correct option is C. To calculate the levered value of the firm, we need to first calculate the levered equity value and the value of the debt. The levered equity value is the present value of the firm's perpetuity earnings, and the value of the debt is the present value of the bond's cash flows. The levered value of the firm is the sum of the levered equity value and the value of the debt.

Step-by-step explanation:

To calculate the levered value of the firm, we need to first calculate the levered equity value and the value of the debt. The levered equity value is the present value of the firm's perpetuity earnings, which is $879,000 divided by the cost of equity of 18.3% (18.3% = 0.183). Therefore, the leveraged equity value is $4,800,546 ($879,000 / 0.183).

The value of the debt is the present value of the bond's cash flows. The bond has a face value of $6.2 million and an annual coupon rate of 8.5%. Using the formula for the present value of a bond, we can calculate the value of the debt as $6,200,000 x (1 - (1 / (1 + 0.085))) / 0.085 = $72,111,765.29. The levered value of the firm is the sum of the levered equity value and the value of the debt, which is $4,800,546 + $72,111,765.29 = $76,912,311.29. Therefore, the correct answer is option C. $6,422,225.