Question

Companies U and L are identical in every respect except that U is unlevered while L has $18 million of 8% 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 $2 million. (4) The unlevered cost of equity is 10%. 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 What is rs for Firm U? Round your answer to one decimal place. % What is rs for Firm L? Do not round intermediate calculations. Round your answer to one decimal place. % Find SL, and then show that SL + D = VL 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. SL = $ million SL + D = $ million 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