(2) Company CDE is financed entirely with equity. The company is thinking of borrowing $900,000. The...
- (2) Company CDE is financed entirely with equity. The company is thinking of borrowing $900,000. The loan will be repaid in equal instalments over the next two years, and has a 8% interest rate. The tax rate is 35%. According to the MM proposition with taxes, what would be the increase in the value to CDE after the loan? Show your work.
Homework Answers
As per MM proposition with taxes, the increase in value will be the present value of tax shielding of interest of loan.
Tax shielding of Interst Amount of Year 1 = 900,000 * 8% * 0.35 = 25200
Tax shielding of Interst Amount of Year 2 = (900,000 - 450,000) * 8% * 0.35= 12600
***Since half the loan will be paid at the year end 1 450,000 has been subtracted above.
Present Value of Tax Shielding = 25200 / (1+0.08)^1 + 12600/ (1+0.08)^2 = 34,135.80
Increase in value will be $34,135.80
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