Two firms, No Leverage Inc. and High Leverage Inc. have equal levels of operating risk and differ only in their capital structure. No Leverage is unlevered and High Leverage has $400,000 of perpetual debt in its capital structure. Assume that the perpetual annual income of both firms available for stockholders is paid out as dividends. Hence, the growth rate for both firms is zero. The income tax rate for both firms is 40 percent. Assume that there are no financial distress costs or agency costs. You are given the following data: No Leverage, Inc. High Leverage, Inc. Equity in capital structure $ 800,000 $ 400,000 Cost of equity, ke 12.5 % 20 % Debt in capital structure - $ 400,000 Pretax cost of debt, kd - 5 % Net operating income (EBIT) $ 100,000 $ 100,000
Two firms, No Leverage Inc. and High Leverage Inc. have equal levels of operating risk and differ only in their capital structure. No Leverage is unlevered and High Leverage has $400,000 of perpetual debt in its capital structure. Assume that the perpetual annual income of both firms available for stockholders is paid out as dividends. Hence, the growth rate for both firms is zero. The income tax rate for both firms is 40 percent. Assume that there are no financial distress costs or agency costs. You are given the following data: No Leverage, Inc. High Leverage, Inc. Equity in capital structure $ 800,000 $ 400,000 Cost of equity, ke 12.5 % 20 % Debt in capital structure - $ 400,000 Pretax cost of debt, kd - 5 % Net operating income (EBIT) $ 100,000 $ 100,000
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Two firms, No Leverage Inc. and High Leverage Inc. have equal levels of operating risk and differ only in their capital structure. No Leverage is unlevered and High Leverage has $400,000 of perpetual debt in its capital structure. Assume that the perpetual annual income of both firms available for stockholders is paid out as dividends. Hence, the growth rate for both firms is zero. The income tax rate for both firms is 40 percent. Assume that there are no financial distress costs or agency costs. You are given the following data:
| No Leverage, Inc. | High Leverage, Inc. | |||||||
| Equity in capital structure | $ | 800,000 | $ | 400,000 | ||||
| 12.5 | % | 20 | % | |||||
| Debt in capital structure | - | $ | 400,000 | |||||
| Pretax cost of debt, kd | - | 5 | % | |||||
| Net operating income (EBIT) | $ | 100,000 | $ | 100,000 |
Determine the
- Market value of No Leverage, Inc. Round your answer to the nearest dollar.
$
- Market value of High Leverage, Inc. Round your answer to the nearest dollar.
$
Present value of the tax shield to High Leverage, Inc. Round your answer to the nearest dollar.
$
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