Question

Alexandria's Dance Studio is currently an all equity firm that has 60,000 shares of stock outstanding with a market price of $24 a share. The current cost of equity is 11% and the tax rate is 40%. Alexandria is considering adding $2 million of debt with a coupon rate of 7% to her capital structure. The debt will be sold at par value. What is the levered value of the equity?

Answer 1

Answer:

$240,000

Explanation:

According to MM Theory with taxes,

the Value of Levered Firm = Value of Unlevered Firm + Tax shield

Hence,

The Value of Levered Firm:

= (60,000 × 24) + ($2,000,000 × 40%)

= $1,440,000 + $800,000

= $2,240,000

Hence,

Levered Value of Equity:

= Value of Levered Firm - Value of Debt

= $2,240,000 - $2,000,000

= $240,000