Calculate the cost of equity: Assuming that there is an unlevered firm and a levered firm. The basic information is given by the following table.   Table 1: Information of the firms   Unlevered firm Levered firm EBIT 10,000 10,000 Interest 0 3,200 Taxable income 10,000 6,800 Tax (tax rate: 34%) 3,400 2,312 Net income 6,600 4,488 CFFA 0 -3,200   Assuming that cost of debt =8%; unlevered cost of capital =10%; systematic risk of the asset is 1.5   Fill in the blanks What is the present value of the tax shield? Cost of Capital = (10% x 0.5) + (8% x 0.5 x (1-0.34) = 7.64% PV of Tax Shield = (3,200 x 0.34) / (1+0.0764) = 1,010.78 What is the size of debt? Interest / Cost of Debt (3,200 / 8%) = 40,000 Calculate the following values:a) Value of Unlevered Firm 10,000 x (1-34%) / 10%  6,600 / 10% = 66,000 b) Value of the Levered Firm             66,000 + 34% x 40,000             66,000 + 13,600 = 79,600 c) Equity Value             79,600 = Equity Value + 40,000             Equity Value = 79,600 – 40,000 = 39,600

Essentials Of Investments
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ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
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Chapter1: Investments: Background And Issues
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Calculate the cost of equity:

Assuming that there is an unlevered firm and a levered firm. The basic information is given by the following table.

 

Table 1: Information of the firms

 

Unlevered firm

Levered firm

EBIT

10,000

10,000

Interest

0

3,200

Taxable income

10,000

6,800

Tax (tax rate: 34%)

3,400

2,312

Net income

6,600

4,488

CFFA

0

-3,200

 

Assuming that cost of debt =8%; unlevered cost of capital =10%; systematic risk of the asset is 1.5

 

  • Fill in the blanks
  • What is the present value of the tax shield?

Cost of Capital = (10% x 0.5) + (8% x 0.5 x (1-0.34) = 7.64%

PV of Tax Shield = (3,200 x 0.34) / (1+0.0764) = 1,010.78

  • What is the size of debt?

Interest / Cost of Debt

(3,200 / 8%) = 40,000

  • Calculate the following values:
    a) Value of Unlevered Firm

10,000 x (1-34%) / 10%

 6,600 / 10% = 66,000

  1. b) Value of the Levered Firm

            66,000 + 34% x 40,000

            66,000 + 13,600 = 79,600

  1. c) Equity Value

            79,600 = Equity Value + 40,000

            Equity Value = 79,600 – 40,000 = 39,600

 

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