CA Final · Advanced Financial Management · Financial Policy and Corporate Strategy
Rohini Textiles Ltd has an expected EBIT of ₹60 lakh, an effective tax rate of 25% and a capital structure with 12% debt of ₹200 lakh. Using the Modigliani-Miller proposition with corporate taxes, and assuming the cost of equity for an all-equity firm is 15%, what is the value of the levered firm?
The levered firm is worth ₹350 lakh. Unlevered value is 60 x 0.75 / 0.15 = ₹300 lakh, and under MM with corporate taxes the interest tax shield adds tax rate times debt, 25% of ₹200 lakh = ₹50 lakh, giving ₹350 lakh.
- A₹300 lakh
- B₹350 lakhCorrect
- C₹260 lakh
- D₹290 lakh
Explanation
Unlevered value Vu = EBIT(1-t)/Ke = 60 x 0.75 / 0.15 = ₹300 lakh. Levered value VL = Vu + t x D = 300 + 0.25 x 200 = ₹350 lakh. Option ₹300 lakh ignores the tax shield on debt, which is the key MM-with-tax benefit.
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