Consider the Modigliani and Miller world of corporate taxes.An unleveraged (all-equity)firm value is $80 million.By adding debt,the annual interest expense is $10 million,the corporate tax rate is 20%,and the discount rate on the tax shield is 8.0%.What is the value of the firm after adding debt?

Question

Quizplus · Accepted Answer

According to the Modigliani and Miller world, the value of the firm after adding debt can be calculated as follows:

V_L = V_U + TCB

where V_L is the value of the leveraged firm, V_U is the value of the unleveraged firm, TCB is the present value of the tax shield on debt.

In this case, the value of the unleveraged firm (V_U) is $80 million. The annual interest expense is $10 million, and the corporate tax rate is 20%, which means the present value of the tax shield on debt (TCB) is:

TCB = $10 million x 0.20 / 0.08 = $25 million

So, the value of the leveraged firm (V_L) is:

V_L = $80 million + $25 million = $105 million

Therefore, the correct choice is C - $105 million.

Consider the Modigliani and Miller World of Corporate Taxes