Companies U and L are identical in every respect except that U is unlevered while L has Sh 10 million of 5% bonds outstanding.Assume

(a) That all of the MM assumptions are met

(b) That there are no corporate or personal taxes

(c) That EBIT is Sh 2 million

(d) That the cost of equity to company U is 10%

Required:

i.Determine the value MM would estimate for each firm

ii.Determine the cost of equity for both firms

iii.What is the overall cost of capital for both firms

iv.Suppose the value of U is Sh 20 million and that of L is Sh 22 million.

Explain the arbitrage process for a shareholder who owns 10% of company L's shares.