MM with Corporate Taxes

Companies U and L are identical in every respect except that U is unlevered while L has $20 million of 5% bonds outstanding. Assume: (1) All of the MM assumptions are met. (2) Both firms are subject to a 25% federal-plus-state corporate tax rate. (3) EBIT is $3 million. (4) The unlevered cost of equity is 12%.

1. What value would MM now estimate for each firm? (Hint: Use Proposition I.) Enter your answers in millions. For example, an answer of $10,550,000 should be entered as 10.55. Round your answers to two decimal places.

   Company U: $ million Company L: $ million

2. What is r_s for Firm U? Round your answer to one decimal place.

   %

   What is r_s for Firm L? Do not round intermediate calculations. Round your answer to one decimal place.

   %

3. Find S_L, and then show that S_L + D = V_L results in the same value as obtained in Part a. Enter your answers in millions. For example, an answer of $10,550,000 should be entered as 10.55. Do not round intermediate calculations. Round your answers to two decimal places.

   S_L = $ million

   S_L + D = $ million

4. What is the WACC for Firm U? Do not round intermediate calculations. Round your answer to two decimal places.

   %

   What is the WACC for Firm L? Do not round intermediate calculations. Round your answer to two decimal places.

   %