Consider the Modigliani and Miller world of corporate taxes.An unleveraged (all-equity)firm value is $100 million.By adding debt,the annual interest expense is $10 million,the corporate tax rate is 40%,and the discount rate on the tax shield is 10%.What is the value of the firm after adding debt?

Question

Quizplus · Accepted Answer

The value of the firm after adding debt can be calculated using the formula: 
Value of Levered Firm = Value of Unlevered Firm + (Tax Shield * Discount Rate on Tax Shield)
Tax Shield = Annual Interest Expense * Corporate Tax Rate = $10 million * 40% = $4 million
Value of Levered Firm = $100 million + ($4 million / 10%) = $140 million

Consider the Modigliani and Miller World of Corporate Taxes