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Alexandria's Dance Studio is currently an all-equity firm with earnings before interest and taxes of $338,000 (in perpetuity ) and a cost of equity of 14.2%. Assume the tax rate is 22%. The firm is considering adding $400,000 of debt with a coupon rate of 7% to its capital structure. The debt will be sold at par value. What is the levered value of the equity

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Answer:

$1,544,620

Explanation:

Calculation to determine the levered value of the equity

First step is to calculate the VE

VL = {[$338,000 × (1 - .22)] / .142} + (.22 × $400,000)

VL=($338,000*0.78/.142)+$88,000

VL=($263,640/.142)+$88,000

VL=$1,856,620+$88,000

VL = $1,944,620

Now let calculate the levered value of the equity

VE = $1,944,620 - $400,000

VE = $1,544,620

Therefore the levered value of the equity is $1,544,620

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