Lollipop Corp. provides the following information:EBIT = $286.50Tax (TC )= 35%Debt= $810Cost of debt capital = 10%RU = 15%What is the value of the firm?Multiple Choice$1,050.72$1,241.53$1,525.03$1,654.91$1,784.03
Question
Lollipop Corp. provides the following information:EBIT = 810Cost of debt capital = 10%RU = 15%What is the value of the firm?Multiple Choice1,241.531,654.91$1,784.03
Solution
To calculate the value of the firm, we need to use the Modigliani-Miller theorem, which states that the value of a firm is independent of its capital structure in a market without taxes. However, since we have a tax rate, we need to adjust the formula to account for the tax shield provided by the debt.
The formula for the value of a firm (V) in this case is:
V = EBIT * (1 - TC) / RU + Tax Shield
where: EBIT = Earnings Before Interest and Taxes TC = Tax rate RU = Cost of equity Tax Shield = Debt * TC
First, let's calculate the Tax Shield:
Tax Shield = Debt * TC = 283.5
Next, calculate the after-tax EBIT:
After-tax EBIT = EBIT * (1 - TC) = 186.225
Finally, we can calculate the value of the firm:
V = After-tax EBIT / RU + Tax Shield = 283.5 = 283.5 = $1525.33
So, the closest answer is $1,525.03.
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