- What is the value of the firm if:

unlevered cost of the equity is 10 percent.  
The pretax cost of debt is 7% per annum 
The annual interest expense is $400,000
A company expects perpetual EBIT of $2.4 million/year.    
There is a 35% corporate tax rate.


- what percentage of the firm?s capital structure would be financed by
debt if there are no extra costs i.e. bankruptcy

Please show work highlevel is fine

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Clarification of Question by rr64519-ga on 03 Sep 2005 08:36 PDT

Question:

I see you are using the following formula VL = VU = {[(EBIT)(1-Tc)] / r0} +  TcB.

But I dont get why you are deviding the debt tax sheild by 7%.  Is
that considered cost of debt?

value of firm = 
unlevered firm value plus debt tax sheild
value of unlevered firm (100% EQUITY FINANCED) = 2.4 * (1-.35) /10% = 15.6 Mill
(since 2.4 is pre tax after tax  = 2.4 * (1-tax) = 1.56 Mill and since
its perpectual its assumed to be the free cash inflow,)
value  of debt tax sheild = 400,000 * 35% /7%  = 2 Mill

Value of firm (divided in equity & debt) = 15.6 + 2 = 17.60 Mill

Question:

I see you are using the following formula VL = VU = {[(EBIT)(1-Tc)] / r0} +  TcB.

But I dont get why you are deviding the debt tax sheild by 7%.  Is
that considered cost of debt?