Marlinda and Martin (M&M) Inc is an all equity financed company with an EBIT of $1.2 million today. The EBIT of the company has been increasing at a constant rate of 4% per year since its establishment. This growth in the companys EBIT is expected to continue forever as well. The companys weighted average cost of capital with its all equity financed capital structure is 12%. Moreover, the company pays 25% in taxes to the government.

a. Calculate the value of the company with its current capital structure.

b. While driving to work this morning, Marlinda, one of the owners of the M&M Inc., heard a guest on a radio talk show recommend companies to borrow as much as they can to increase the wealth of their owners. She mentioned this to Martin, the other owner of the M&M Inc., in their morning meeting. They invited the CFO of the company to this meeting and asked the CFO to determine how much the M&M Inc. can borrow to have a capital structure with 40% debt and 60% equity financing.

c. The CFO talked to the primary bank of the company and guaranteed a loan from this bank for the amount determined in part (b) of this question at an interest rate of 8%. When CFO delivered this information to Marlinda and Martin, they want the CFO to calculate (i) the value of the firms equity, (ii) the cost of equity of the company and (iii) the WACC of the company and briefly discuss the effect of this proposed capital structure change on these variables.

d. Marlinda and Martin are puzzled by the CFOs calculations and cannot understand how a change in the companys capital structure can affect the value and the WACC of the company. Briefly explain Marlinda and Martin the reason for this change in the value of the firm and its WACC after borrowing money.

e. Given the change in the firm value and the WACC of the company, briefly discuss if it is beneficial for the M&M Inc. to change its capital structure from all equity to 40% debt and 60% equity financing.