Question

MM with Corporate Taxes

Companies U and L are identical in every respect except that U is unlevered while L has $20 million of 6% bonds outstanding. Assume that: (1) All of the MM assumptions are met. (2) Both firms are subject to a 35% federal-plus-state corporate tax rate. (3) EBIT is $4 million. (4) The unlevered cost of equity is 10%.

1. What value would MM now estimate for each firm? (Hint: Use Proposition I.) Enter your answers in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. 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 $1.2 million should be entered as 1.2, not 1,200,000. 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