Question

1. The Aggie Company has EBIT of $50,000 and market value debt of $100,000 outstanding with a 9% coupon rate. The cost of equity for an all equity firm would be 14%. Aggie has a 35% corporate tax rate. Investors face a 20% tax rate on debt receipts and a 15% rate on equity. Determine the value of Aggie.

Answer 1

Answer:

$263,081

Explanation:

Leverage is the condition of the gearing company. The debt of the company makes it the levered company. It account for the debt factor of the company. Whereas unlevered company has no debt.

Unlevered Value of the company = EBIT x ( 1 - Corporate Tax ) / unlevered cost of equity

Unlevered Value of the company = $50,000 x ( 1 - 35% ) / 14% = $232,143

Levered Value of the company = Unlevered Value of the company + debt x ( 1 - (1-corporate tax rate)*(1-tax on equity rate)/(1-tax on debt receipts)

Levered Value of the company = $232,143 + $100,000 x ( 1 - ( 1 - 0.35 ) x (1-0.15)/(1-0.2)

Levered Value of the company = $263,081

Answer 2

Answer:

$263,080.36

Explanation:

Aggie Company

Unlevered firm = [$50,000 (.65)]/ .14

=$32,500/.14

= $232,142.86

Miller leverage tax shield value =

[1 - ((1 - Tc)(1 - Ts)/(1 - Tb))]B

= [1 - ((1 - .35)(1 - .15)/1 - .20))]*$100,000

=[1-(0.65)(0.85)/0.8]*$100,000

=[1-05525/0.8]*$100,000

=(1-0.690625)*$100,000

=0.309375*$100,000

= $30,937.50

Hence:

Total Value = $232,142.86 + $30,937.50

= $263,080.36

Therefore the value of Aggie company will be

$263,080.36