Companies U and L are identical in every respect except U is unlevered while L has $10 milliom of 5% bonds outstanding. Assume (1) that all of the MM assumptions are me

Companies U and L are identical in every respect except U is unlevered while L has $10 milliom of 5% bonds outstanding. Assume (1) that all of the MM assumptions are met, (2) that there are no corporate or personal taxes, (3) the EBIT is $2 million and (4) that the cost of equity of Company U is 10%.

a. What value would MM estimate for each firm?
b. What is rs for Firm U? Firm L?
c. Find SI, and then show that SL +D=V=$20 million.
d. What is the WACC for Firm U? For Firm L?

TUTORIAL PREVIEW
a.

       V_U = EBIT (1 – T)

                     r _s U
       
             = $2 (1 – 0.4)
                        0.10


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