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Vader Corp. is a firm that generates a perpetual EBIT of $50,000 per year. The firm...

Vader Corp. is a firm that generates a perpetual EBIT of $50,000 per year. The firm currently has no debt and has 50,000 shares outstanding. The cost of capital is 10%. The firm is thinking of issuing $200,000 in debt and using the proceeds to repurchase equity. The firm could borrow the funds at 8%.

  1. If there are no corporate taxes and M&M Proposition I holds, what would be the market value of Vader Corp. if it issues the debt and repurchases the shares?

Answer is $500000 - need an in-depth solution.

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Answer #1

Value of Unlevered Firm = [EBIT*(1-t)] / r = [$50,000*(1-0)] / 0.10 = $500,000

Value of levered firm = Value of Unlevered Firm + [t * Debt]

= $500,000 + [0*$200,000] = $500,000

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