Question

Lazare Corporation expects an EBIT of $33,000 every year forever. Lazare currently has no debt, and its cost of equity is 16%. The firm can borrow at 10%.

a. If the corporate tax rate is 35%, what is the value of the firm?

Value of the firm = ?

b. What will the value be if the company converts to 60% debt?

Value of the firm            $?

c. What will the value be if the company converts to 100% debt?

Value of the firm ?

Answer 1

a. Value of unlevered firm =

$Value of unlevered firm = \frac{EBIT(1-T)}{K_{e}}$

$Value of unlevered firm = \frac{\$33000(1-.35)}{16\%}$

$Value of unlevered firm = \$134062.5$

b. value be if the company converts to 60% debt

$Value of levered firm = Value of unlevered firm + Tax saving on debt$

$Value of levered firm = \$134062.5 + (\$134062.5^{*}.6^{*}.35)$

$Value of levered firm = \$134062.5 + \$28153.13$

$Value of levered firm = \$162215.63$

c.value be if the company converts to 100% debt

$Value of levered firm = Value of unlevered firm + Tax saving on debt$

$Value of levered firm = \$134062.5 + (\$134062.5^{*}.35)$$Value of levered firm = \$134062.5 + \$46921.88$

$Value of levered firm = \$180984.38$

I hope this clear your doubt.

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