Damon Corporation's value with no debt is $270 million. However, the firm uses $70 million in debt financing, and its corporate tax rate is 40 percent. Damon's CFO is trying to value the firm now. The appropriate personal tax rates on debt and stock income are 35 and 15 percent, respectively. By how much does the firm's value change, if the CFO values Damon using Modigliani and Miller's corporate taxes model instead of the corporate and personal taxes model?
A) $8.54 million
B) $9.68 million
C) $12.92 million
D) $13.20 million
E) $14.52 million

Question

Quizplus · Accepted Answer

The value change using the Modigliani and Miller's corporate taxes model is calculated as the tax shield on debt, which is $70 million * 40% = $28 million. Using the corporate and personal taxes model, the value change is $70 million * (1 - (1 - 0.4) * (1 - 0.35) / (1 - 0.15)) = $15.08 million. The difference is $28 million - $15.08 million = $12.92 million.

Damon Corporation's Value with No Debt Is $270 Million