The Montana Hills Co.has expected earnings before interest and taxes of $17,100,an unlevered cost of capital of 12.4 percent,and debt with both a book and face value of $25,000.The debt has an annual 6.2 percent coupon.If the tax rate is 21 percent,what is the value of the firm?
A)$91,016
B)$137,903
C)$114,194
D)$106,667
E)$146,403

Question

Quizplus · Accepted Answer

Step 1: Calculate the after-tax cost of debt
After-tax cost of debt = pre-tax cost of debt x (1 - tax rate)
= 6.2% x (1 - 0.21)
= 4.898%
Step 2: Calculate the weighted average cost of capital (WACC)
WACC = (unlevered cost of capital x equity weight) + (after-tax cost of debt x debt weight)
Debt weight = debt / (debt + equity) = $25,000 / ($25,000 + equity)
Equity weight = 1 - debt weight
WACC = (12.4% x (1 - debt weight)) + (4.898% x debt weight)
Step 3: Calculate the firm value
Firm value = EBIT / WACC
= $17,100 / (0.124 x (1 - debt weight) + 0.049 x debt weight)
= $114,194 (rounded to the nearest dollar)