Answer and Explanation:
The computation is shown below:
a. The current value of the company is
As it is mentioned that the company has no debt that means it is unlevered firm that is equivalent to unlevered value of the company
Unlevered value of the firm = Vu
Vu = EBIT × (1 - tax rate ) ÷ unlevered Cost of Equity
= EBIT × (1 - tax rate ) ÷ R0
= $25,000 × (1 - 0.22 ) ÷ 12%
= $162,500
b-1.
The computation of the value of the firm in the case when the value of the firm is equivalent to 50% of unlevered value
VL = Vu + Borrowing × tax rate
where,
Debt = borrowing = 50% × unlevered value of company
Debt = borrowing = 50% x Vu
So,
VL = Vu + Borrowing x tax rate
VL = $162,500 + ($162,500 × 50%) × 22%
= $162,500 + $17,875
= $180,375
b-2.
The computation of the value of the firm in the case when the value of the firm is equivalent to 100% of unlevered value
Levered value of the firm VL
VL = Vu + Borrowing × tax rate
Debt = borrowing = 100% × unlevered value of company
Debt = borrowing = 100% × Vu
So,
VL = Vu + Borrowing x tax rate
= $162,500 + ($162,500 × 100%) × 22%
= $162,500 + 35,750
= $198,250
C.1.
The computation of the value of the firm in the case when the value of the firm is equivalent to 50% of the levered value
VL = Vu + Borrowing × tax rate
= Vu + (VL × 50%) × tax rate
VL = Vu + (VL × 50%) × 22%
VL = Vu + 0.11 VL
VL - 0.11 VL = 162,500
0.89 VL = 162,500
VL= 182,584.27
C.2.
The computation of the value of the firm in the case when the value of the firm is equivalent to 100% of the levered value
Levered value of the firm VL
VL = Vu + Borrowing x tax rate
VL = Vu + (VL × 100%) × tax rate
= Vu + (VL × 100%) × 22%
= Vu + 0.22 VL
VL - 0.22 VL = 162,500
0.78 VL = 162,500
VL= $208,333.33
