17-6: Capital Structure Theory: Arbitrage Proofs of the Modigliani-Miller Theorems

Problem 17-6 MM without Taxes

Companies U and L are identical in every respect except that U is unlevered while L has $9 million of 7% bonds outstanding. Assume that (1) there are no corporate or personal taxes, (2) all of the other MM assumptions are met, (3) EBIT is $3 million, and (4) the cost of equity to Company U is 12%.

What value would MM estimate for each firm? 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 two decimal places. % What is rs for Firm L? Do not round intermediate calculations. Round your answer to two decimal places. %

Find SL. Round your answer to two decimal places. Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. $ million

What is the WACC for Firm U? Round your answer to one decimal place. % What the WACC for Firm L? Round your answer to one decimal place. %

Suppose VU = $20 million and VL = $22 million. According to MM, are these values consistent with equilibrium? -Select-Yes / No