ABC Inc. expects to generate cash flows of $1 million per year in perpetuity. The firm is 100% equity financed and its cost of equity is 10%.

suppose the corporate tax rate is 40%

*

*What is the value of the unlevered firm?

*Suppose the firm changes its capital structure to 50% debt at an interest rate of 5%.

*According to M&M, what is the value of the levered firm?

*What will be the new cost of equity?

*What is the new WACC?

*Use the WACC to estimate firm value. Do you get the same answer?