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 value increases by the tax shield on the debt. The tax shield is $1 million * 8% * 34% = $27,200. The initial firm value is 200,000 shares * $20 = $4 million. The new firm value is $4 million + $0.272 million = $4.340 million.

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