Millennium Motors has current pretax annual cash flows of $1,000 and is in the 35% tax bracket. The appropriate discount rate for its cash flows is 12%. Suppose the firm issues a $1,500 bond and uses these proceeds to pay a one-time special dividend to stockholders. Using the perpetuity model, calculate the value of the firm without debt in the capital structure. Assume that the pretax annual cash flows are perpetual. Round to the nearest dollar.

Question

Quizplus · Accepted Answer

The value of the firm without debt is calculated using the perpetuity formula: Value = Cash Flow * (1 - Tax Rate) / Discount Rate. Here, it is $1,000 * (1 - 0.35) / 0.12 = $5,417.

Millennium Motors Has Current Pretax Annual Cash Flows of $1,000