Question

4. Binford Tools has an expected EBIT = $67,000 in perpetuity and a tax rate = 35%. The firm has $139,000 in outstanding debt at an interest rate = 6.85%. Its unlevered cost of capital is 10.25%. What is the value of the firm according to M&M Proposition 1 with taxes?

Answer 1

The value of Binford Tools according to M&M Proposition I with taxes is $473,772.

This calculation considers the tax shield on interest payments and uses the firm's given financial data, including its EBIT, tax rate, debt, and unlevered cost of capital.

Step-by-step explanation:

The question asks us to calculate the value of Binford Tools according to Modigliani and Miller Proposition I with taxes (M&M Proposition I with taxes).

To find the value of the firm, we will use the following formula, which takes into account the tax shield due to interest payments:

V = EBIT(1-T) / Ru + (TC * D)

Where:
V = Value of the firm
EBIT = Earnings before interest and taxes
T = Tax rate
Ru = Unlevered cost of capital
TC = Tax rate (again, since the tax shield is TC * D)
D = Debt of the firm

We are given:
EBIT = $67,000
T = 35%
D = $139,000
Ru = 10.25%
Interest rate on debt = 6.85%

Now, let's calculate the value of the firm:
V = ($67,000 * (1 - 0.35)) / 0.1025 + (0.35 * $139,000)
V = $43,550 / 0.1025 + $48,650
V = $425,122.0 + $48,650
V = $473,772.0

Therefore, the value of the firm according to M&M Proposition I with taxes is $473,772.