Question

The Bellwood Company is financed entirely with equity. The company is considering a loan of $3.3 million. The loan will be repaid in equal principal installments over the next two years and has an interest rate of 7 percent. The company’s tax rate is 22 percent.

  

According to MM Proposition I with taxes, what would be the increase in the value of the company after the loan

Answer 1

Calculate the increase in value of the company as follows:

A B C D 32 Particulars Amount Year 1 Year 2 33 Interest rate 7% 34 Tax rate 22% 35 Loan $3,300,000 36 Instalment amount $1,650,000 37 38 Interest amount $231,000 $115,500 39 Tax shield $50,820 $25,410 40 PVF @ 7% 0.934579439 0.873438728 41 PV of amount $47,495 $22,194 42 Increase in value $69,689

Formulas:

D C Year 1 Year 2 А B 32 Particulars Amount 33 Interest rate 0.07 34 Tax rate 0.22 35 Loan =3.3*1000000 36 Instalment amount =B35/2 37 38 Interest amount 39 Tax shield 40 PVF @ 7% 41 PV of amount 42 Increase in value =B35 B33 =(B35-B36)*B33 =C38*B34 =D38*B34 = 1/(1+B33) =1/(1+B33)^2 =C39*C40 =D39*D40 =SUM(C41:041)