ACCA Applied Skills · Financial Management · Capital structure theories and practical considerations
Tarn Co has permanent debt of $20 million at 5% and an ungeared cost of equity of 10%. Its tax rate is 20%, and it has annual after-tax operating cash flows (if ungeared) of $8 million in perpetuity. Under Modigliani and Miller with tax, what is the total market value of Tarn Co?
Tarn's value is $84 million. The ungeared value is $8 million divided by 10%, giving $80 million, and the tax shield on permanent debt adds $20 million times 20%, or $4 million.
- A$80.0 million
- B$84.0 millionCorrect
- C$88.0 million
- D$100.0 million
Explanation
Vu = 8 / 0.10 = $80m. Tax shield = Dt = 20 x 20% = $4m. Vg = 80 + 4 = $84m. Option A omits the tax shield; option D adds the debt itself.
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