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example - two firm u as well as l is identical in

Example: - Two firm U as well as L is identical in every respect except that U is unlevered and L is levered. L has Rs. 20Lakh of 8% debt outstanding. The net operating income of both the firms is identical that is Rs. 6Lakh. The corporate tax rate is 35% as well as equity capitalization rate for U is 10%. Find out the value of every firm according to the MM Approach.

Solution:-

(i) Value of Unlevered Firm U:-

EBIT 6, 00,000

Less: Interest Nil

_________

Earning before tax 6,00,000

Less : Tax @ 35% 2,10,000

_________

Earning After Tax 3,90,000

__________

Cost of Equity (K_e) 10%

__________

Value of the firm = EBIT (1-t)/ K_e

Value of the firm (Vu) = 3, 90,000/10% = 39, 00,000

(ii) Value of Levered Firm L

V_L = V_u + D_t

V _L= 39, 00,000 + 20, 00,000 (.35)

V_L = 39, 00,000 + 7, 00,000

V_L= 46, 00,000

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