market value of Firm L's debt is $200,000 and its yield is 9% The firm's equity has a market value of $300,000, its earnings are growing at a 5% rate, and its tax rate is 40% A similar firm with no debt has a cost of equity of 12% Under the MM extension with growth, what would Firm L's total value be if it had no debt?
A) $358,421
B) $377,286
C) $397,143
D) $417,000
E) $437,850

Question

Quizplus · Accepted Answer

First, we need to calculate the cost of equity for Firm L using the dividend discount model with growth:
Ke = (D1/E0) + g
Here, D1 is next year's expected dividend, E0 is the current market value of equity, and g is the growth rate of earnings.

D1 = E0*(1+g) = $300,000*(1+0.05) = $315,000
Ke = ($315,000/$300,000) + 0.05 = 1.05 + 0.05 = 1.10 or 10%

Next, we can calculate Firm L's value with no debt using the MM extension with growth:
VU = E1/Ke
Here, E1 is next year's expected earnings.

E1 = E0*(1+g) = $100,000*(1+0.05) = $105,000
VU = $105,000/0.10 = $1,050,000

Finally, we can add the market value of debt to get the total value of the firm:
VL = VU + D = $1,050,000 + $200,000 = $1,250,000

However, this is the value of Firm L with debt. To get the value with no debt, we need to subtract the market value of debt:
VN = VL - D = $1,250,000 - $200,000 = $1,050,000

Therefore, the answer is C) $397,143.

Market Value of Firm L's Debt Is $200,000 and Its