The Studio is currently an all-equity firm that has 68,000 shares of stock outstanding with a market price of $36.80 a share.The current cost of equity is 11.7 percent,and the tax rate is 35 percent.The firm is considering adding $750,000 of debt with a coupon rate of 5.8 percent to its capital structure.The debt will be sold at par value.What is the levered value of the equity?
A)$2,014,900
B)$3,035,500
C)$1,785,000
D)$2,005,200
E)$1,806,400

Question

Quizplus · Accepted Answer

The levered value of the equity is the value of the equity after the firm has added debt to its capital structure. The levered value of the equity can be calculated using the following formula:Levered value of equity = Unlevered value of equity + (PV of tax savings * (1 - Tax rate))The unlevered value of equity is the value of the equity before the firm has added debt to its capital structure. The unlevered value of equity can be calculated using the following formula:Unlevered value of equity = Number of shares outstanding * Market price per shareThe PV of tax savings is the present value of the tax savings that the firm will receive from the interest payments on the debt. The PV of tax savings can be calculated using the following formula:PV of tax savings = Interest payments * Tax rate * (1 / (1 + Cost of equity)^n)where:n is the number of years that the debt will be outstandingIn this case, the number of shares outstanding is 68,000, the market price per share is $36.80, the cost of equity is 11.7 percent, the tax rate is 35 percent, the coupon rate on the debt is 5.8 percent, and the debt will be sold at par value. The number of years that the debt will be outstanding is not given, so we will assume that it is 10 years.Using these values, we can calculate the levered value of the equity as follows:Levered value of equity = Unlevered value of equity + (PV of tax savings * (1 - Tax rate))Levered value of equity = 68,000 * $36.80 + (0.058 * $750,000 * 0.35 * (1 / (1 + 0.117)^10))Levered value of equity = $2,505,600 + $149,300Levered value of equity = $2,654,900Therefore, the levered value of the equity is $2,654,900.

The Studio Is Currently an All-Equity Firm That Has 68,000