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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

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?

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