Consider the Modigliani and Miller world of corporate taxes.An unlevered (all-equity)firm value is $200 million.By adding debt,the annual interest expense is $40 million,the corporate tax rate is 25%,and the discount rate on the tax shield is 6%.What is the value of the firm after adding debt?

Question

Quizplus · Accepted Answer

The value of the firm after adding debt is $425 million. This is because the tax shield from the interest expense is worth $10 million per year ($40 million x 25%). The present value of this tax shield is $166.67 million ($10 million / 6%). Adding this to the original value of the firm gives a total value of $425 million.

Consider the Modigliani and Miller World of Corporate Taxes