Answer:
Levered, Inc. and Unlevered, Inc.
Equity shares in the Levered, Inc. represents a better value.
Explanation:
a) Data and Calculations:
Levered, Inc. Unlevered, Inc.
Debts at 8% 65 million $0
Outstanding shares 1.9 million 3.8 million
Market price per share $98 $71
Equity value $186.2 million $269.8 million
Expected EBIT $18 million $18 million
Interest ($65 million * 8%) $5.2 million $0
Net income $12.8 million $18 million
Earnings per share $6.74 $4.74
Dividends per share $6.74 $4.74
b) The value of the equity shares in the Levered Inc. would have increased more if both firms pay taxes because of the tax advantage gained by deducting interest expense from the earnings before taxes. This shows that financial leverage increases the value of equity shares.
