ACCA FM · Chapter 12 · Question 3 of 9
An ungeared company has a market value of $50m. According to Modigliani and Miller's theory with corporate tax, if an otherwise identical company has $20m of irredeemable debt and the tax rate is 25%, what is the market value of the geared company's equity?
Test yourself: pick an answer
Reveal answer & explanation
Correct answer: B) $35m
Explanation
MM with tax: Vg = Vu + TB = 50 + (20 x 0.25) = $55m. The value of equity is the total value less the value of debt: 55 - 20 = $35m. $55m is the value of the whole geared company, not its equity.
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