Question

Kline Construction is an all-equity firm that has projected perpetual earnings before interest and taxes of $628,000. The current cost of equity is 17.6 percent and the tax rate is 35 percent. The company is in the process of issuing $4.3 million of 8.3 percent annual coupon bonds at par. What is the levered value of the firm?

Answer 1

Based on the information given the levered value of the firm is $3,824,318.

First step is to calculate the Unlevered firm value

Unlevered firm value = EBIT(1 - Tax) / Cost of equity

Unlevered firm value= $628,000 x (1-.35)/.176

Unlevered firm value= $628,000 x (1-.35)/.176

Unlevered firm value = $628.000×.65/.176

Unlevered firm value = $2,319,318

Second step is to calculate Levered firm value

Levered firm value = Unlevered firm value + (Tax rate× Debt))

Levered firm value= $2,319,318 + (.35 x $4,300,000)

Levered firm value= $2,319,318 +$1,505,000

Levered firm value = $3,824,318

Inconclusion the levered value of the firm is $3,824,318.

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