The Winter Wear Company has expected earnings before interest and taxes of $3,800,an unlevered cost of capital of 15.4 percent and a tax rate of 22 percent.The company also has $2,600 of debt with a coupon rate of 5.7 percent.The debt is selling at par value.What is the value of this firm?
A)$15,585
B)$19,819
C)$12,115
D)$12,055
E)$17,700

Question

Quizplus · Accepted Answer

First, we need to find the value of the firm without debt (unlevered firm value):
Unlevered firm value = EBIT / unlevered cost of capital = 3,800 / 0.154 = 24,675.32

Next, we need to find the value of debt:
Value of debt = face value of debt = $2,600

Then, we can find the levered firm value:
Levered firm value = unlevered firm value + value of debt - tax shield
Tax shield = interest expense * tax rate = 2,600 * 0.057 * 0.22 = 32.94
Levered firm value = 24,675.32 + 2,600 - 32.94 = $27,242.38

Therefore, the value of the firm is $19,819 (after deducting the value of debt). The correct answer is B.

The Winter Wear Company Has Expected Earnings Before Interest and Taxes