Question

Kline Construction is an all-equity firm that has projected perpetual EBIT of $328,000. The current cost of equity is 12.5 percent and the tax rate is 34 percent. The company is in the process of issuing $944,000 worth of perpetual bonds with an annual coupon rate of 6.7 percent at par. What is the value of the levered firm?

O $1,924,267
O $1,988,533
O $1,731,840
O $2,052,800
О $1,558,656

Answer 1

The value of the levered firm is approximately $2,645,406.72.

Step-by-step explanation:

To calculate the value of the leveraged firm, we need to use the adjusted present value (APV) method. First, calculate the present value of the perpetuity using the cost of equity. Plugging in the numbers, we have:

EBIT / Cost of Equity

= $328,000 / 0.125

= $2,624,000

Next, calculate the present value of the tax savings from the interest expense on the perpetual bonds. The tax savings can be calculated as:

Tax Savings = Interest Expense × Tax Rate

= ($944,000 × 0.067) × 0.34

= $21,406.72

Finally, add the present value of the perpetuity and the present value of the tax savings to get the value of the levered firm:

Value of Levered Firm = Present Value of Perpetuity + Present Value of Tax Savings

= $2,624,000 + $21,406.72

= $2,645,406.72

Therefore, the value of the levered firm is approximately $2,645,406.72.