Final answer:
The value of the leveraged firm according to M&M Proposition I with taxes is calculated by adding the tax shield from the debt to the perpetuity value of the firm's EBIT post-taxes, and then dividing by the unlevered cost of capital. The calculated value for Tool Manufacturing is $626,469.03.
Step-by-step explanation:
To find the value of the firm according to M&M Proposition I with taxes, we use the formula:
Calculate the tax shield on debt: Interest on debt × Tax rate.
Add the tax shield to the perpetuity value of the firm's EBIT.
The tax shield on the firm's debt is: $245,000 × 5.4% × 22% = $2,911.
To annualize this value because it's a perpetuity, we simply use the tax shield as an ongoing annual saving. We add the EBIT less taxes to the tax shield to find the value of the leveraged firm:
VL = (EBIT × (1 - Tax rate) + Tax shield) / Unlevered cost of capital = ($87,000 × (1 - 22%) + $2,911) / 11.3%.
Calculating, we get:
VL = ($87,000 × 0.78 + $2,911) / 0.113 = ($67,860 + $2,911) / 0.113 = $70,771 / 0.113 = $626,469.03
Hence, the value of the leveraged firm is $626,469.03.