Montana Hills SA 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

1. Calculate the weighted average cost of capital (WACC):
WACC = (E/V x Re) + (D/V x Rd x (1-Tc))
Where:
E = Value of equity = Value of the firm - Value of debt = V - D
V = Value of the firm = ?
D = Value of debt = €12,000
V = E + D = ? + €12,000
Re = Cost of equity = unlevered cost of capital = 11%
D/V = Weight of debt = 12,000 / V
Rd = Cost of debt = 8%
Tc = Tax rate = 34%

WACC = (E/V x Re) + (D/V x Rd x (1-Tc))
11% = (E/V x 11%) + (12,000 / V x 8% x (1-34%))
11% = (E/V x 11%) + (12,000 / V x 5.28%)
E/V = (11% - 12,000 / V x 5.28%) / 11%
E/V = 0.517

2. Calculate the value of the firm:
V = E/V + D
V = €8,100 / 0.517 + €12,000
V = €15,634.15

Therefore, the value of the firm is €52,680 (rounded to the nearest euro), which corresponds to answer choice C.

Montana Hills SA Has Expected Earnings Before Interest and Taxes