ACCA Applied Skills · Financial Management · Capital structure theories and practical considerations
Ranton Co is ungeared with a market value of $40 million and pays tax at 25%. It issues $10 million of permanent debt and uses the proceeds to repurchase shares. Under Modigliani and Miller with tax, what is the value of Ranton Co after the restructuring?
The geared value is $42.5 million. Under Modigliani and Miller with tax, value equals the ungeared value of $40 million plus the tax shield on permanent debt, which is $10 million times 25%, or $2.5 million.
- A$37.5 million
- B$40.0 million
- C$42.5 millionCorrect
- D$50.0 million
Explanation
Value geared = Vu + Dt = 40 + (10 x 25%) = 40 + 2.5 = $42.5 million. Option B ignores tax, as in the no-tax theory. Option D wrongly adds the whole debt amount.
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