Answer:
$880,000
Step-by-step explanation:
First note that the full meaning of EBIT is earning before interest and tax.
When the company does not have debt, it called unlevered (VU), while a company that has debt is called levered (VL) company. The VU and the VL of the company can be calculated using the VU and VL formula as follows:
Step 1. Calculation of VU
VU = [EBIT × (1 - tax rate)] ÷ cost of equity
= [$100,000 × (1 - 0.20)] ÷ 0.10
= [$100,000 × 0.80] ÷ 0.10
= $80,000 ÷ 0.10
= $800,000
Step 2. Calculation of VL
VL = VBC + (tax rate × conversion rate × VU)
= $800,000 + (0.20 × 0.5 × $800,000)
= $800,00 + $80,000
= $880,000
Therefore, the value of the firm will be $880,000 if it is converted to 50 percent debt.
