What is the change in value for a firm with $1 million in equity, $1 million in permanent debt at a 10% interest rate, and a 35% tax rate if MM I is modified to recognize corporate taxes?

Question

Quizplus · Accepted Answer

The modification of MM I to recognize corporate taxes suggests that there are tax implications for the firm's capital structure. With $1 million in permanent debt at a 10% interest rate, the firm would have to pay $100,000 in interest expenses per year. Since interest expenses are tax-deductible, the tax shield would be equal to $100,000 x 35% = $35,000. This means that the value of the firm would increase by the present value of the tax shield, which is $35,000 / 0.1 = $350,000. Therefore, the correct answer is C.

What Is the Change in Value for a Firm with $1