A Calgary firm with no debt has 200,000 shares outstanding valued at $20 each. Its cost of equity is 12%. The firm is considering adding $1 million in debt to its capital structure. The coupon rate would be 8% and the bonds would sell for par value. The firm's tax rate is 34%. How much will the firm be worth after adding the debt?
A) $4.033 million
B) $4.180 million
C) $4.340 million
D) $4.660 million
E) $5.000 million

Question

Quizplus · Accepted Answer

The firm's current value is $4 million (200,000 shares * $20). The tax shield from the debt is $1 million * 0.34 = $340,000. Therefore, the firm's value after adding the debt is $4 million + $340,000 = $4.34 million.

A Calgary Firm with No Debt Has 200,000 Shares Outstanding