Miller Model

Companies U and L are identical in every respect except that U is unlevered while L has $10 million of 8% bonds outstanding. Both firms have an EBIT of $3 million. Assume that all of the MM assumptions are met.

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.

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%.

a. What is the value of the unlevered firm, VU?

b. What is the value of the levered firm, VL?

2. Keep the other assumptions (D = $10 million, rd = 8%, EBIT = $3 million, and rsU = 10%) but now suppose Td = Ts = 0 and Tc = 40%.

a. What is the value of the unlevered firm, VU?

b. What is the value of the levered firm, VL?

3. Keep the other assumptions (D = $10 million, rd = 8%, EBIT = $3 million, and rsU = 10%) but now suppose that Td = 28%, Ts = 28%, and Tc = 40%.

a. Now what is the value of the levered firm?

b. What is the gain from leverage?