The Dart Company is financed entirely with equity The compan

The Dart Company is financed entirely with equity. The company is considering a loan of $1.71 million. The loan will be repaid in equal principal installments over the next two years, and it has an interest rate of 9 percent. The company\'s tax rate is 40 percent According to MM Proposition I with taxes, what would be the increase in the value of the company after the loan? (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) Increase in the value

Solution

Based on Miller Modigliani Proposition with Taxes, value of company would increase by PV of tax shield provided by the interest on loan.

So, in order to calculate the value of this tax shield, we need to calculate loan interest and hence interest tax shield for each year. The schedule for loan planned by the company would be:

For Year 1: Interest = 1,710,000 * 9% = 153,900; Tax Shield = 153,900 * 40% = 61,560.

Equal principal amount would be repaid in each year (as given in question). Hence $1,710,000/2 = $855,000 would be paid back, with the same amount remaining as outstanding.

For Year 2: Interest = 855,000 * 9% = 76,950; Tax Shield = 76,950 * 40% = 30,780.

Now, we need to calculate the PV of this tax shield amounts at year 0.

PV of tax shield = 61560/(1 + 9%) + 30,780/(1 + 9%)²

PV of tax shield = 56,477.06 + 25,906.91 = $82,383.97 ---> Increase in Value. Answer