EBT = 3741- 1045= 2426

2426 x80 %= 1940.8

Npv=10b - 400m/(1+4%) -400m/(1+4%)^2-…=0

 So 2 and 3 is also correct

The Modigliani-Miller theorem (M&M) states that the market value of a company is correctly calculated as the present value of its future earnings and its underlying assets, and is independent of its capital structure. At its most basic level, the theorem argues that, with certain assumptions in place, it is irrelevant whether a company finances its growth by borrowing, by issuing stock shares, or by reinvesting its profits. Developed in the 1950s, the theory has had a significant impact on corporate finance.

 

1.     the required rate of return on the firm's assets - Ra
 
 2. the firms cost of debt - Rd
 
 3. the firm's debt-equity ratio - D/E

 

The total systematic risk of a firm's equity has two parts: business risk and financial risk. The business risk depends on the firm's assets and operations and is not affected by capital structure. Given the firm's business risk (and its cost of debt), the financial risk is completely determined by financial policy. The firm's cost of equity rises when it increases the use of financial leverage because the financial risk of the equity increases while the business risk remains the same.

 

If,

Using these parameters, the relationship between the value of an unlevered firm and the value of levered firm once we consider the effects of corporate taxes can be given as shown below:

Where,

Here, T X D represents the interest tax shield. So, the value of levered firm is more than the value of unlevered firm by the amount of interest tax shield once corporate tax is considered.