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ACCA Strategic Professional · Advanced Financial Management · Financial strategy formulation

Dalmar plc is all-equity financed with a value of £100m and cost of equity 10%. Ignoring personal tax and using Modigliani and Miller with corporate tax at 20%, it issues £30m of permanent debt and uses the proceeds to repurchase shares. What is the value of the geared company?

The geared value is £106m. Under Modigliani and Miller with corporate tax, value rises by the present value of the tax shield on permanent debt, which is debt × tax rate, so £100m plus £30m × 20% equals £106m.

  1. A£100m
  2. B£106mCorrect
  3. C£130m
  4. D£94m

Explanation

With corporate tax, Vg = Vu + D × t = £100m + £30m × 20% = £106m. Option £100m ignores the tax shield, £130m adds the whole debt, and £94m wrongly subtracts the shield.

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