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Mini Case:
17  23
The Value Of U
= Expected FCF/(WACC – g)
= 250,000/(0.14 – 0.07) = $3,571,429
Which is greater than in part C because the firm is growing.
If there is $1,000,000 in debt then:
The value of
l
= the value of U + value of debt tax shield
The value of the (growing) debt tax shield = r
d
TD/(r
sU
– g)
= 0.08(0.40)(1,000,000)/(0.14 – 0.07)
= $457,143
Therefore, the value of the firm = $3,571,429 + $457,143 = $4,028,571.
The value of the equity is the value of the firm less the value of the
debt = $4,028,571  $1,000,000 = $3,028,571.
In this case the increase in the firm’s value due to the debt tax shield as a percent of
its zero debt value is $457,143/$3,571,429 = 12.80%
This is less than the increase in the nongrowing firm’s value as calculated using the
MM model: $400,000/$2,142,857 = 18.7%.
To calculate the new levered cost of equity:
r
sL
= r
sU
+ (r
sU
– r
d
)(D/S)
= 14% + (14%  8%)(1,000,000/3,028,571)
= 15.98%
And the new levered WACC:
WACC
L
= (D/V)r
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 Spring '08
 Staff
 Debt

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