3. Compton Corporation currently has no debt in its capital structure. Its cost of equity is 13 percent. It is considering substituting $8,000 in debt at 6 percent interest. The EBIT for the firm is $5,000 under either scenario. The tax rate is 35 percent.

Unlevered Firm Levered Firm

EBIT $ 5,000 5,000

Interest 0 480

EBT 5,000 4,520

Taxes (.35) 1,750 1,582

Net Income 3,250 2,938

a. What is the value of the unlevered firm? (circle the answer, then show your work).

a. $16,000

b. $17,500

c. $25,000

d. $32,500

b. How much value will be added to the firm by substituting $8,000 in debt? (circle the answer, then show your work)

a. $1,688

b. $1,750

c. $2,800

d. $3,250

c. What is the value of equity for the levered firm?

d. Calculate the cost of equity for the levered firm. (show your work)