A firm has expected net operating income ((X)) of ($ 600). Its value as an unlevered firm

Question:

A firm has expected net operating income $(X)$ of $\$ 600$. Its value as an unlevered firm $\left(V_{U}\right)$ is $\$ 2,000$. The firm is facing a tax rate of $40 \%$. Suppose the firm changes it ratio of debt to equity ratio to equal 1 . The cost of debt capital in this situation is $10 \%$. Use the MM propositions to:

1. Calculate the after-tax cost of equity capital for both the levered and the unlevered firm.

2. Calculate the after-tax weighed average cost of capital for each.

3. Why is the cost of equity capital higher for the levered firm, but the weighted average cost of capital lower?

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