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Cargill, Inc. is currently an all equity firm that has 180,000 shares of stock outstanding with...

Question

Cargill, Inc. is currently an all equity firm that has 180,000 shares of stock outstanding with...

Cargill, Inc. is currently an all equity firm that has 180,000 shares of stock outstanding with a market price of $50.50 a sh
Cargill, Inc. is currently an all equity firm that has 180,000 shares of stock outstanding with a market price of $50.50 a share. The current cost of equity is 12.6 percent and the tax rate is 25 percent. The firm is considering adding $3.76 million of debt with a coupon rate of 5.5 percent to its capital structure. The debt will be sold at par value. What eis the levered value of the equity? $6,540,000 $6,827,800 $7,142,900 $7,381,470 $6,270,000

Answers

No of outstanding shares = 180,000

Market Price = $50.50 per share

Value of un-levered firm = 180,000 * 50.50 =  $9,090,000

We can solve this problem using the Modigliani-Miller Theorem (M&M):

This theory says that the value of a levered firm is equal to the value of an identical un-levered firm plus the tax benefit it derives from the presence of debt in its capital structure.

Here Tax benefit = Value of Debt * Tax rate

= $3,760,000 * 25%

= $940,000

Therefore, Value of the firm = Value of un-levered firm + Tax benefit

=$9,090,000 + $940,000

= $10,030,000.

Value of levered equity = Value of firm - Value of Debt

= $10,030,000 - $3,760,000

= $ 6,270,000


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