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?
A) Value increases by $35,000.
B) Value increases by $100,000.
C) Value increases by $350,000.
D) Value increases by $700,000.

Question

Quizplus · Accepted Answer

With MM I, the value of the firm is V = E + D. However, with corporate taxes, the value of the firm is V = (E - TcB) + (D - B), where Tc is the corporate tax rate and B is the present value of the interest tax shield. 
In this case, with $1 million in equity and $1 million in permanent debt at a 10% interest rate, B = $100,000. 
Using the formula, V = (E - TcB) + (D - B), we get V = ($1 million - 0.35*$100,000) + ($1 million - $100,000) = $1.35 million. 
Therefore, the change in value is $350,000.

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