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KN&J expects its EBIT to be $138,000 every year forever. The firm can borrow at 10 percent. KN&J currently has no debt and its cost of equity is 17.2 percent. The tax rate is 35 percent. What will the value of KN&J be if the firm borrows $50,000 and uses the loan proceeds to repurchase shares?

Respuesta :

Answer:

$ 539,011.62

Explanation:

Given;

Expected EBIT = $ 138,000

Firm can borrow = 10%

Cost of equity = 17.2 %

Tax rate = 35%

Amount borrowed = $ 50,000

VU = { Expected EBIT × (1 - tax rate) } / {Cost of equity}

or

VU = { $ 138,000  × (1 - 0.35) } / {0.172}

or

VU = $ 521,511.62

Now,

The value of KN&J = VU + ( Amount borrowed × Tax rate )

or

The value of KN&J = $ 521,511.62 + ( 50,000 × 0.35 )

or

The value of KN&J = $ 539,011.62

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