Kline Construction is an all-equity firm that has projected perpetual EBIT of $320,000. The current cost of equity is 12.3 percent and the tax rate is 40 percent. The company is in the process of issuing $936,000 worth of perpetual bonds with an annual coupon rate of 6.5 percent at par. What is the value of the levered firm

$1,879,215.61

Explanation:

Given that,

EBIT = $320,000

Current cost of equity = 12.3%

Tax rate = 40 percent

Value of perpetual bonds = $936,000

Annual coupon rate = 6.5 percent at par

Value of the unlevered firm:

= [EBIT × (1 - Tax rate)] ÷ Current cost of equity

= [$320,000 × (1 - 0.4)] ÷ 0.123

= $192,000 ÷ 0.123

= $1,560,975.61

Value of the levered firm:

= Value of the unlevered firm + (Tax rate × Value of perpetual bonds)

= $1,560,975.61 + (0.34 × $936,000)

= $1,560,975.61 + $318,240

= $1,879,215.61

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