# An unlevered firm has a value of \$800 million. An otherwise identical but levered firm has \$60 million in debt at a 5% interest rate

Category:
 ▲ 0 ▼ ♥ 0 An unlevered firm has a value of \$800 million. An otherwise identical but levered firm has \$60 million in debt at a 5% interest rate, which is its pre-tax cost of debt. Its unlevered cost of equity is 11%. After Year 1, free cash flows and tax savings are expected to grow at a constant rate of 3%. Assuming the corporate tax rate is 25%, use the compressed adjusted present value model to determine the value of the levered firm. (Hint: The interest expense at Year 1 is based on the current level of debt.)
Explanation Value of unlevered firm=\$800m   Then tax the debt Tax benefit(shield)=25%*\$60m=\$15m As constant growth is 3%.The benefit=60m*25%*5%*(1+3%)/(5%-3%)=\$38.625m So the value of levered...

Explanation

Value of unlevered firm=\$800m

Then tax the debt
Tax benefit(shield)=25%*\$60m=\$15m
As constant growth is 3%.The benefit=60m*25%*5%*(1+3%)/(5%-3%)=\$38.625m
So the value of levered firm=value of unlevered firm+ Debt tax benefit
So the value of levered firm=800m+38.625m=838.625m
Adjusted levered firm's value is 838.625 million