An unlevered company has a cost of capital of 14.6 percent and earnings before interest and taxes of $240,090. A levered company with the same operations and assets has a face value of debt of $85,000 with a coupon rate of 7.5 percent that sells at par. The applicable tax rate is 22 percent. What is the value of the levered company?

$1,301,372.6

Explanation:

Given that,

Cost of capital of unlevered company = 14.6%

Earnings before interest and taxes of unlevered company = $240,090

Face value of debt of levered company = $85,000

Coupon rate = 7.5%

Applicable tax rate = 22%

Earnings after Tax:

= Earnings before Income and Taxes of Unlevered Firm - Taxes

= $240,090 - ($240,090 × 22%)

= $240,090 - $52,819.8

= $187,270.2

Value of Unlevered Firm:

= Earnings after Tax ÷ Cost of capital

= $187,270.20 ÷ 0.146

= $1,282,672.6

Value of levered firm:

= Value of Unlevered firm + Tax Shield on Debt

= $1,282,672.6 + ($85,000 × 0.22)

= $1,282,672.6 + $18,700

= $1,301,372.6

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