Problem 15-1 Firm Value Connor Corp. has an EBIT of $1,000,000 per year that is
ID: 2657369 • Letter: P
Question
Problem 15-1 Firm Value
Connor Corp. has an EBIT of $1,000,000 per year that is expected to continue in perpetuity. The unlevered cost of equity for the company is 13 percent, and the corporate tax rate is 35 percent. The company also has a perpetual bond issue outstanding with a market value of $1.97 million.
What is the value of the company? (Enter your answer in dollars, not millions of dollars. Do not round intermediate calculations and round your answer to the nearest whole dollar, e.g., 1,234,567.)
Value of the company $
Explanation / Answer
Using Modigliani and Miller Approach:
Value of firm : = [EBIT (1 - t)/ U ] + [ P × t ]
Where :
t = tax rate
U = unleverered cost of equity
P = outstanding perpetual bond value
= [ 1,000,000 (1 - 0.35)/ 0.13] + [1,970,000 × 0.35]
= 5,000,000 + 689,500 = $5,689,500
Value of firm is $5,689,500