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IAI Actuarial Core Principles · Business Finance · Personal and corporate taxation

Using the Modigliani-Miller proposition with corporate taxes (no personal taxes, no bankruptcy costs), an unlevered firm has value Rs 500 crore. The tax rate is 30%. It then issues permanent debt of Rs 100 crore and uses the proceeds to repurchase shares. What is the value of the levered firm?

The levered firm is worth Rs 530 crore. Under MM with corporate tax, value rises by the present value of the tax shield on permanent debt, which is 30% of Rs 100 crore, or Rs 30 crore, added to the unlevered value of Rs 500 crore.

  1. ARs 470 crore
  2. BRs 530 croreCorrect
  3. CRs 600 crore
  4. DRs 500 crore
  5. Rs 570 crore

Explanation

With corporate tax, V_L = V_U + T x D = 500 + 0.30 x 100 = Rs 530 crore. Rs 500 crore ignores the tax shield (the no-tax result). Rs 600 crore adds the whole debt rather than the tax shield.

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