Two firms, No Leverage, Inc. and High Leverage Inc.have equallevels of
QUESTION
Two firms, No Leverage, Inc. and High Leverage Inc.have equallevels of operating risk and differ only in their capitalstructure. No Leverage is unlevered and High Leverage has$500,000 of perpetual debt in its capital structure. Assumethat the perpetural annual income of both firms availa
No Leverage Inc. High Leverage Inc. EBIT (Net Operating Income) $100,000 $100,000 Less: Interest (7% on debt) — $35,000 Earnings Before Tax (EBT) $100,000 $65,000 Less: Tax (40%) $40,000 $26,000 Net Income $60,000 $39,000 (a) Market Value of No LeverageInc.
= $60,000 / 0.10 = $600,000 (b) Market Value of High Leverage Inc =[$39,000 / 0.13 $35,000/0.07] = $800,000 ( c) Tax Shield on High Leverage Inc. =$500,000 * 0.40 = $200,000
ANSWER:
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