Final answer:
The correct answer is option 2. The value of the levered firm, after accounting for the tax shield benefit obtained from $10,000 of debt at a 35% tax rate, is $31,125.
Step-by-step explanation:
The student's question involves calculating the value of a levered firm, which is a concept in corporate finance. To find the value of a levered firm, one must account for the tax shield benefit of debt. Using the given data: Best Foods, Inc. has an unlevered cost of capital of 10% and generates EBIT of $4,250 per year, with a tax rate of 35%. If the firm adds $10,000 of debt, the tax shield on this debt can be calculated as the amount of debt times the tax rate (i.e., $10,000 * 35% = $3,500).
The value of the unlevered firm can be found by dividing the after-tax EBIT by the unlevered cost of capital. The after-tax EBIT is the EBIT less taxes, i.e., $4,250 * (1 - 0.35) = $2,762.50. The value of the unlevered firm is thus $2,762.50 / 0.10 = $27,625.
To find the value of the levered firm, we add the tax shield to the value of the unlevered firm: $27,625 (unlevered firm value) + $3,500 (tax shield) = $31,125.
Therefore, the value of the levered firm is $31,125.