Question
Companies U and L are identical in every respect except that U is unlevered while L has $8 million of 5% bonds outstanding. Both firms
Companies U and L are identical in every respect except that U is unlevered while L has $8 million of 5% bonds outstanding. Both firms have an EBIT of $2 million. Assume that all of the MM assumptions are met.
1. Suppose that both firms are subject to a 35% federal-plus-state corporate tax rate, investors in both firms face a tax rate of Td = 28% on debt income and Ts = 20% (on average) on stock income, and the appropriate required pre-personal-tax rate rsU is 10%.What is the value of the unlevered firm, VU? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to two decimal places. $ million 2. What is the value of the levered firm, VL? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to two decimal places. $ million 3. What is the gain from leverage? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to two decimal places. $ million
4. Now keep the other assumptions (D = $8 million, rd = 5%, EBIT = $2 million, and rsU = 10%) but set Tc = Ts = Td = 0. What is the value of the unlevered firm, VU? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to two decimal places. $ million
5. What is the value of the levered firm, VL? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to two decimal places. $ million 6. What is the gain from leverage? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to two decimal places. $ million
7. Keep the other assumptions (D = $8 million, rd = 5%, EBIT = $2 million, and rsU = 10%) but now suppose Td = Ts = 0 and Tc = 40%. What is the value of the unlevered firm, VU? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to two decimal places. $ million
8. What is the value of the levered firm, VL? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to two decimal places. $ million
9. What is the gain from leverage? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to two decimal places. $ million
10. Keep the other assumptions (D = $8 million, rd = 5%, EBIT = $2 million, and rsU = 10%) but now suppose that Td = 28%, Ts = 28%, and Tc = 40%. Now what is the value of the levered firm? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to two decimal places. $ million
11. What is the gain from leverage? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to two decimal places. $ million
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