Question
Asked Nov 27, 2019
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What is the size of debt for each firm?

Assume that cost of debt = 8%; unlevered cost of capital = 10%; systematic risk of the asset is 1.5

А
В
C
Unlevered Firm Levered Firm
10,000
3,200
6,800
2,312
4,488
3,200
1
2 EBIT
10,000
3 Interest
4 Taxable Income
10,000
3,400
6,600
5 Tax (tax rate: 34%)
6 Net Income
7 CFFA
0
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А В C Unlevered Firm Levered Firm 10,000 3,200 6,800 2,312 4,488 3,200 1 2 EBIT 10,000 3 Interest 4 Taxable Income 10,000 3,400 6,600 5 Tax (tax rate: 34%) 6 Net Income 7 CFFA 0

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Expert Answer

Step 1

The firm with zero debts can be said as unlevered firm. This is so because these firm do not have financial leverage which only generated if firm borrow money from investors.

Step 2

The debt for levered firm i...

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Interest on debt = Debt amount x Cost of debt $3,200 Debt amount x 0.08 $3,200 = Debt amount 0.08 $40,000 Debt amount

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