← 2. Corporate Theories

Exercises

Problems to check your understanding of this chapter. The solutions are folded away — try them yourself first.

Easy

1EasyCompute

A firm earns EBIT=200EBIT = 200 every year forever. The required return is 10%10\% and the corporate tax rate is 30%30\%.

By how much does firm value rise when debt grows from 00 to 400400?

A firm with EBIT 200200, tax rate 30%30\%, debt 400400
Show solution

  1. The rise in firm value equals the rise in the tax shield: ΔV=TcΔD=0.30×400=120\Delta V = T_c \Delta D = 0.30 \times 400 = 120.

  2. Unlevered value is 200×(1−0.30)/0.10=1400200 \times (1 - 0.30) / 0.10 = 1400, so with debt of 400400 the value is 15201520.

Answer

It rises by 120120, from 14001400 to 15201520