Question

Companies U and L are identical in every respect except that U is unlevered while L has $8 million of 6% bonds outstanding. Assume: (1) All of the MM assumptions are met. (2) Both firms are subject to a 25% federal-plus-state corporate tax rate. (3) EBIT is $3 million. (4) The unlevered cost of equity is 9%.

1. What value would MM now estimate for each firm? (Hint: Use Proposition I.) Enter your answers in millions. For example, an answer of $10,550,000 should be entered as 10.55. Round your answers to two decimal places.

   Company U: $    million
   Company L: $    million

2. What is r_s for Firm U? Round your answer to one decimal place.

     %

   What is r_s for Firm L? Do not round intermediate calculations. Round your answer to one decimal place.

     %

3. Find S_L, and then show that S_L + D = V_L results in the same value as obtained in Part a. Enter your answers in millions. For example, an answer of $10,550,000 should be entered as 10.55. Do not round intermediate calculations. Round your answers to two decimal places.

   S_L = $    million

   S_L + D = $    million

4. What is the WACC for Firm U? Do not round intermediate calculations. Round your answer to two decimal places.

     %

   What is the WACC for Firm L? Do not round intermediate calculations. Round your answer to two decimal places.

     %

Answer 1

1.
=3*(1-25%)/9%=25

2.
=3*(1-25%)/9%+8*25%=27

3.
=9.00%

4.
=9%+(9%-6%)*8/(3*(1-25%)/9%+8*25%-8)*(1-25%)=9.94736842105263%

5.
=3*(1-25%)/9%+8*25%-8=19

6.
=3*(1-25%)/9%+8*25%-8+8=27

7.
=9.00%

8.
=8/(3*(1-25%)/9%+8*25%)*6%*(1-25%)+(3*(1-25%)/9%+8*25%-8)/(3*(1-25%)/9%+8*25%)*(9%+(9%-6%)*8/(3*(1-25%)/9%+8*25%-8)*(1-25%))=8.33333333333333%