An unlevered firm has a cost of capital of 16 percent and earnings before interest and

taxes of $225,000. A levered firm with the same operations and assets has both a book value

and a face value of debt of $850,000 with an 8 percent annual coupon. Assume no taxes and no bankruptcy.

 

Part 1) What is the Value of the levered Firm?

Part 2) What is the value of equity?

a) Value of a levered firm= $1,406,250.00 

b) Value of Equity = $ 556,250.00 

Step-by-step explanation

a) Value of a levered firm

Value of a levered firm= Value of unlevered firm+(tax rate*value of debt)

Step 1. Find the value of unlevered firm.

Value of Unlevered Firm= [EBIT* (1- tax rate)]/ Cost of Capital

Given,

EBIT=225,000

tax rate= 0%

Cost of Capital= 16%

Substitute:

Value of Unlevered Firm= [EBIT* (1- tax rate)]/ Cost of Capital

Value of Unlevered Firm= [225000*(1-0%)]/16%

Value of Unlevered Firm= 225000/16%

Value of Unlevered Firm=  1,406,250.00 
 

Step 2. Find the value of levered firm.

Value of a levered firm= Value of unlevered firm+(tax rate*value of debt)

Substitute:

Value of a levered firm= 1,406,250+ (0%*850000)

Value of a levered firm= 1,406,250+0

Value of a levered firm= $1,406,250.00 

b) Value of Equity

Value of Equity = Value of Levered Firm - Value of Debt

Given,
Value of a levered firm= 1,406,250.00 (part a)

Value of debt= 850,000

Substitute:

Value of Equity = Value of Levered Firm - Value of Debt

Value of Equity = 1,406,250.00 - 850,000

Value of Equity = $ 556,250.00