Market value of Leverage, Inc a. 100,000 (1-.40) = 600,000 .10 Market Value of H
ID: 2661458 • Letter: M
Question
Market value of Leverage, Inc
a.
100,000 (1-.40) = 600,000
.10
Market Value of High Leverage, Inc
b.
100,000 + 65,000-(1-.40) = 21,000
Present value of the tax shield to High Leverage, Inc.
c.
a. NoLeverage, Inc. HighLeverage, Inc.
Netoperating income(EBIT) $100,000 $100,000
Less: interest payments(I) --- $35,000
Earnings beforetaxes $100,000 $65,000
Income taxes(40%) 40,000 26,000
Income available to
stockholders(D) $60,000 $39,000
Total income availableto
security holders (I +D) $60,000 $74,000
Market value (NoLeverage) = $60,000/0.10 =????????????
b. Market value (High Leverage) =$39,000/0.13 + $35,000/0.07 = ?????????????
c. Presentvalue (tax shield) = $500,000 x 0.40 =$???????
Explanation / Answer
No Leverage Inc.
High Leverage Inc.
No Leverage Inc.
High Leverage Inc.
EBIT (Net Operating Income) $100,000 $100,000 Less: Interest (7% on debt) --- $35,000 Earnings Before Tax (EBT) $100,000 $65,000 Less: Tax (40%) $40,000 $26,000 Net Income $60,000 $39,000 (a) Market Value of No LeverageInc. = $60,000 / 0.10 = $600,000 (b) Market Value of High Leverage Inc =[$39,000 / 0.13 + $35,000/0.07] = $800,000 ( c) Tax Shield on High Leverage Inc. =$500,000 * 0.40 = $200,000