Question

BioWare Company has expected earnings before interest and taxes of $1,650,000, an unlevered cost of capital of 9.6 percent, and a tax rate of 25 percent. The company has $6,700,000 of debt that carries a 5.5 percent coupon. The debt is selling at par value. What is the value of this E-company? $12,871,096 $13,829,657 C $15,208,413 $14,565,625 C$16,218,747

Answer 1

$14,565,625

Firstly, calculate the unlevered value of Firm.

EBIT = $1,650,000

Tax rate = 25%

Net Income = 1,650,000*(1-0.25) = $1,237,500

Unlevered cost of equity = 0.096

Thus,

Value of unlevered Firm (Vu) = 1,237,500/0.096 = $12,890,625

Now, We can use MM proposition -I with tax to compute the value of levered firm.

$\textup{Value of levered firm = value of unlevered firm + Value of debt*tax rate}$

$\textup{Value of levered firm = 12,890,625+ 6,700,000*0.25}$

$\textup{Value of levered firm = 12,890,625+ 1,675,000}$

$\bg_green \large \textup{Value of levered firm = \$14,565,625}$

Hope this will help, please do comment if you need any further explanation. Your feedback would be highly appreciated.