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In the absence of any leverage, Oil Crop, would have equity worth $63 million. However, it's...

In the absence of any leverage, Oil Crop, would have equity worth $63 million. However, it's has $23 million of debt, and the level of debt will remain constant permanently. Oil has not changed the scale of its operations because of the leverage. The corporate tax rate is 20%. Oil's required return on debt is 7%. What is the value of the firm?

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Answer #1

In the absence of any leverage, Oil Crop, would have equity worth $63 million

So unlevered value of firm = 63 million

Debt amount however =23 million

Tax rate =20%

PV of interest tax shield = Debt Amount*tax rate

=23*20%

=$4.6 Million

As per MM preposition, if there is taxes, levered value of firm will be Equal to unlevered value of firm + PV of interest tax shield

=63 + 4.6 million

=67.6 million

So value of firm will be $67.6 million

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