Question
Firm U and Firm L are identical in every respect except that U is unlevered while L has $10 million of 5% bonds outstanding. Assume
Firm U and Firm L are identical in every respect except that U is unlevered while L has $10 million of 5% bonds outstanding. Assume that all of the MM assumptions are met, there are no corporate or personal taxes, EBIT is $2 million, and the cost of equity to Company U is 10%.
- What value would MM estimate for each firm?
- What is ks for Firm U? For Firm L?
- Find SL (the value of the equity for Firm L), then show that SL + D = VL = $20 million.
- What is the WACC for Firm U? For Firm L?
- Suppose VU = $20 million and VL = $22 million. According to MM, do these values represent an equilibrium? If not, briefly explain the process by which an equilibrium would be restored.
Please make sure to answer number 5!
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Management and Cost Accounting
Authors: Colin Drury
8th edition
978-1408041802, 1408041804, 978-1408048566, 1408048566, 978-1408093887
