Referring to table below, calculate the market value of firm L (without a corporate income tax) if the equity amount in its capital structure decreases to $5,000 and the debt amount increases to $5,000. At this capital structure, the cost of equity is 15 percent. Round your answer to the nearest dollar.     Firm U Firm L   Net operating income (EBIT)   $ 1,000   $ 1,000     Less: Interest payments to debt holders, I     -     100     Income available to stockholders (dividends), D   $ 1,000   $ 900     Total income available to security holders, I + D   $ 1,000   $ 1,000     Required rate of return on debt, kd     -     5 %   Market value of debt, B = I/kd     -   $ 2,000     Required rate of return on equity,ke     10 %   11.25 %   Market value of equity, E = D/ke   $ 10,000   $ 8,000     Market value of firm, E + B   $ 10,000   $ 10,000

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
icon
Related questions
icon
Concept explainers
Question
100%

Referring to table below, calculate the market value of firm L (without a corporate income tax) if the equity amount in its capital structure decreases to $5,000 and the debt amount increases to $5,000. At this capital structure, the cost of equity is 15 percent. Round your answer to the nearest dollar.

 

  Firm U Firm L
  Net operating income (EBIT)   $ 1,000   $ 1,000  
  Less: Interest payments to debt holders, I     -     100  
  Income available to stockholders (dividends), D   $ 1,000   $ 900  
  Total income available to security holders, I + D   $ 1,000   $ 1,000  
  Required rate of return on debt, kd     -     5 %
  Market value of debt, B = I/kd     -   $ 2,000  
  Required rate of return on equity,ke     10 %   11.25 %
  Market value of equity, E = D/ke   $ 10,000   $ 8,000  
  Market value of firm, E + B   $ 10,000   $ 10,000  
                 

 

$   

 

Expert Solution
trending now

Trending now

This is a popular solution!

steps

Step by step

Solved in 4 steps with 2 images

Blurred answer
Knowledge Booster
Cost of Capital
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.
Similar questions
  • SEE MORE QUESTIONS
Recommended textbooks for you
Essentials Of Investments
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
FUNDAMENTALS OF CORPORATE FINANCE
FUNDAMENTALS OF CORPORATE FINANCE
Finance
ISBN:
9781260013962
Author:
BREALEY
Publisher:
RENT MCG
Financial Management: Theory & Practice
Financial Management: Theory & Practice
Finance
ISBN:
9781337909730
Author:
Brigham
Publisher:
Cengage
Foundations Of Finance
Foundations Of Finance
Finance
ISBN:
9780134897264
Author:
KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher:
Pearson,
Fundamentals of Financial Management (MindTap Cou…
Fundamentals of Financial Management (MindTap Cou…
Finance
ISBN:
9781337395250
Author:
Eugene F. Brigham, Joel F. Houston
Publisher:
Cengage Learning
Corporate Finance (The Mcgraw-hill/Irwin Series i…
Corporate Finance (The Mcgraw-hill/Irwin Series i…
Finance
ISBN:
9780077861759
Author:
Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor
Publisher:
McGraw-Hill Education