Firms U and L are identical companies in every respect except that firm L has long-term debt in its capital structure while firm U does not. Firm L has 200,000, $100 face value bonds on issue. The yield to maturity and coupon rate on the bonds is 8% p.a. Both firms have earnings before interest of $10,000,000 p.a. which are to be distributed to shareholders in full each year. Firm Us investors require a return of 25% on their shares. There are no taxes and all cash flow streams are perpetuities.

a) What is the total market value firm Us equity? Show all calculations.

b) Assume that the total market value of firm L is $50,000,000. Calculate firm Ls overall cost of capital. Show all calculations.

c) Assume that the total market value of firm L is $50,000,000. Calculate firm Ls cost of equity capital. Show all calculations.

d) How did Modigliani and Miller describe the above situation and what did they say would occur in these circumstances? Be specific (no calculations required).