CFA Level I · CFA Level I Exam · Capital Structure
An unlevered firm has a value of 800 million and a tax rate of 25%. It issues permanent debt of 200 million and uses the proceeds to repurchase shares. Under Modigliani-Miller with corporate taxes and no other frictions, the value of the levered firm is closest to:
The levered firm is worth about 850 million. With corporate taxes, value rises by the present value of the tax shield on permanent debt, which is the tax rate times debt: 25% times 200 million equals 50 million, added to 800 million.
- A800 million
- B850 millionCorrect
- C1,000 million
Explanation
VL = VU + t×D = 800 + 0.25×200 = 850 million. The 800 option ignores the interest tax shield; 1,000 wrongly adds the full debt amount instead of the tax shield.
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