A local firm has debt worth $200,000,with a yield of 9%,and equity worth $300,000.It is growing at a 5% rate,and its tax rate is 40%.A similar firm with no debt has a cost of equity of 12%.Using the compressed adjusted present value model,what is the value of your firm's tax shield,i.e. ,how much value does the use of debt add?
A) $92,571
B) $102,857
C) $113,143
D) $124,457
E) $136,903

Question

Quizplus · Accepted Answer

First, find the unlevered cost of equity for the local firm with the formula:

Unlevered Cost of Equity = Cost of Equity / (1 + (1 - Tax Rate) * (Debt/Equity))

Unlevered Cost of Equity = 0.12 / (1 + (1 - 0.40) * (0/3)) = 0.12

Next, use the compressed adjusted present value formula to find the value of the tax shield:

Value of Tax Shield = (Tax Rate * Debt) / (Unlevered Cost of Equity)

Value of Tax Shield = (0.40 * 200,000) / 0.12 = $102,857

Therefore, the value of the tax shield is $102,857, as shown in option B.

A Local Firm Has Debt Worth $200,000,with a Yield of 9%,and