Firm L has debt with a market value of $200,000 and a yield of 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

Under the MM extension with growth, the value of a levered firm is equal to the value of an unlevered firm plus the present value of the tax shield. The unlevered cost of equity is 12%, and the tax shield is calculated using the debt value, tax rate, and yield. The unlevered firm value is calculated by subtracting the tax shield from the levered firm value.

Firm L Has Debt with a Market Value of $200,000