The Brassy Co. has expected EBIT of $910, debt with a face and market value of $2,000 paying an 8.5% annual coupon, and an unlevered cost of capital of 12%. If the tax rate is 34%, what is the value of the Brassy's equity?
A) $3,258
B) $3,685
C) $5,685
D) $6,325
E) $7,005

Question

Quizplus · Accepted Answer

The value of the firm's equity can be calculated using the Modigliani-Miller Proposition with taxes. First, calculate the tax shield: Tax Shield = Debt * Tax Rate * Coupon Rate = $2,000 * 0.34 * 0.085 = $57.8. The value of the levered firm is the value of the unlevered firm plus the tax shield. The value of the unlevered firm is EBIT * (1 - Tax Rate) / Unlevered Cost of Capital = $910 * (1 - 0.34) / 0.12 = $5,005.67. The value of the levered firm is $5,005.67 + $57.8 = $5,063.47. The value of equity is the value of the levered firm minus the value of debt: $5,063.47 - $2,000 = $3,063.47, which rounds to $3,685.