The market value of Firm L's debt is $200,000 and its yield is 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 (V_L) is equal to the value of an unlevered firm (V_U) plus the present value of the tax shield. The formula for the value of an unlevered firm is V_U = EBIT(1-T) / r_U, where r_U is the cost of equity for an unlevered firm. Given that the similar firm with no debt has a cost of equity of 12%, we can calculate V_U. The tax shield is not considered here as we are finding the value if the firm had no debt.

The Market Value of Firm L's Debt Is $200,000 and Its