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otez555 [7]
3 years ago
7

O’Connell & Co. expects its EBIT to be $83,000 every year forever. The firm can borrow at 11 percent. O’Connell currently ha

s no debt, and its cost of equity is 15 percent.
1. If the tax rate is 35 percent, what is the value of the firm? (Round your answer to 2 decimal places. (e.g., 32.16)


2. What will the value be if the company borrows $144,000 and uses the proceeds to repurchase shares? (Round your answer to 2 decimal places. (e.g., 32.16))
Business
1 answer:
andrew11 [14]3 years ago
7 0

Answer:

1. $3,59,666.66

2. $4,10,066.66

Explanation:

1. The computation of value of firm is shown below:-

As the Earning before interest and tax given remains the same, this impact that there is no growth rate in the earnings to consider.

= Earning before interest and tax × (1 - Tax) ÷ Cost of equity

= $83,000 × (1 - 0.35) ÷ (0.15)

= $53,950 ÷ 0.15

= $3,59,666.66

2. The computation of value of levered firm is shown below:-

Value of unlevered firm + Debt × Tax rate

= 3,59,666.66 + ($144,000 × 35%)

= $4,10,066.66

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