MM with Corporate Taxes

Firms U and L are identical in every respect. The information for firms U and L to the right.

Assume that : (1) All of the MM assumptions are met. (2) Both firms are subject to the same federal-plus-state corporate tax rate. (3) EBIT is the same for both firms.($) The unlevered cost of equity, rSU is the same for both firms.

a. What value would MM now estimate for each firm? (Hint: Use Proposition I) (5 points)

b. What is rSL for Firm L? (5 points)

c. Find SL, and then show that SL +D = VL results in the same value as obtained in Part a. (5 points)

d. What is the WACC for Firm U? for Firm L? (10 points)

	U	L
Debt	0	$ 16.00	million
rD	0	5.0%
rSU	10.0%	10.0%
EBIT	$ 3.00	$ 3.00	million
Tax rate	39%	39%

a	VU		million
	VL		million
b	rSL
c	SL		million
	SL + D		million
d	WACCU
	WACCL