Companies U and L are identical in every respect except that U is unlevered while L has $8 million of 8% bonds outstanding. Assume that (1) all of the MM assumptions are met, (2) both firms are subject to a 40% federal-plus-state corporate tax rate, (3) EBIT is $3 million, and (4) the unlevered cost of equity is 20%.

a. What value would MM now estimate for each firm? (Hint: Use Proposition I.)

b. What is rs for Firm U? For Firm L?

c. Find SL , and then show that SL +D = VL results in the same value as obtained in part a.

d. What is the WACC for Firm U? For Firm L?