Question

Problem 16-14 MM and Taxes [LO2] Meyer & Co. expects its EBIT to be $115,000 every year forever. The firm can borrow at 7 percent. The company currently has no debt, and its cost of equity is 13 percent. a. If the tax rate is 24 percent, what is the value of the firm? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) b. What will the value be if the company borrows $255,000 and uses the proceeds to repurchase shares? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

a. The value of the firm is computed as shown below:

= EBIT ( 1 - tax rate ) / cost of equity

= $ 115,000 ( 1 - 0.24 ) / 0.13

= $ 672,307.69 Approximately

b. The value of the firm will be as follows:

= $ 672,307.69 + 0.24 x $ 255,000

= $ 733,507.69

Feel free to ask in case of any query relating to this question