Modigliani & Miller Propositions NoLeverage is a firm financed entirely

with equity and Leverage is a firm financed with $50-50$ equity and debt, but

otherwise the two firms are identical. Both firms have an annual EBIT of $$3$

million and operate in a perfect capital market. Also, for both firms the

required return on assets, $r_A,$ is $10\mathrm{.}0\%$ and the risk$-$free rate is $4\mathrm{.}5\%.$

a$.$ For both firms calculate the total firm value, market value of debt

and equity, and required return on equity.

b$.$ Recalculate the values in part a assuming that the market mistakenly

requires a return on equity of $18\%$ for Leverage.

c$.$ Explain how arbitrage traders will force Leverage firm's value into

equilibrium.