The Montana Hills Co. has expected earnings before interest and taxes of $8,100,an unlevered cost of capital of 11%,and debt with both a book and face value of $12,000. The debt has an annual 8% coupon. The tax rate is 34%. What is the value of the firm?
A) $48,600
B) $50,000
C) $52,680
D) $56,667
E) $60,600

Question

Quizplus · Accepted Answer

Step 1: Calculate the value of the unlevered firm using the following formula:
Value of Unlevered Firm = EBIT / Unlevered Cost of Capital
Value of Unlevered Firm = $8,100 / 11% = $73,636.36

Step 2: Calculate the tax shield value of the debt using the following formula:
Tax Shield Value of Debt = (Debt x Tax Rate x Coupon Rate) / (1 - Tax Rate)
Tax Shield Value of Debt = ($12,000 x 34% x 8%) / (1 - 34%) = $680.57

Step 3: Calculate the value of the levered firm using the following formula:
Value of Levered Firm = Value of Unlevered Firm + Tax Shield Value of Debt - Value of Debt
Value of Levered Firm = $73,636.36 + $680.57 - $12,000 = $62,316.93

Therefore, the value of the firm is $52,680 (rounded to the nearest dollar).