CS Executive · Corporate Accounting and Financial Management · Capital Structure
Under Modigliani-Miller (with corporate taxes), an unlevered firm Arya Ltd has value Rs 10,00,000. It now issues perpetual debt of Rs 4,00,000 and the corporate tax rate is 25%. Using the MM tax-adjusted proposition, what is the value of the levered firm?
The levered firm value is Rs 11,00,000. With corporate tax, value equals unlevered value plus the present value of the tax shield, which is tax rate times debt: 25% of Rs 4,00,000 is Rs 1,00,000, added to Rs 10,00,000.
- ARs 10,00,000
- BRs 11,00,000Correct
- CRs 13,00,000
- DRs 14,00,000
Explanation
Vl = Vu + tax rate x Debt = 10,00,000 + 0.25 x 4,00,000 = 10,00,000 + 1,00,000 = Rs 11,00,000. Rs 10,00,000 ignores the tax shield (the no-tax MM result). Rs 14,00,000 wrongly adds the whole debt.
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