Question
An unlevered firm (=Firm U) and a leveraged firm (=Firm L) have identical operations but their financing decisions are different. Firm L borrowed $4,000,000 at
An unlevered firm (=Firm U) and a leveraged firm (=Firm L) have identical operations but their financing decisions are different. Firm L borrowed $4,000,000 at a cost of 8%. The EBIT is expected to be $1,000,000 every year forever for both companies. Also assume that Dividend Payout Ratio is 100% and corporate tax rate is 40%.
Question: How much value will be added to Firm L due to financial leverage. (Remember: MM Theory assumes there is no bankruptcy cost)
| A. | $128,000 | |
| B. | $4,000,000 | |
| C. | $1,600,000 | |
| D. | $1,000,000 | |
| E. | $728,000 |
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Public Finance
Authors: Harvey Rosen
6th International Edition
0071121234, 978-0071121231
