Modigliani & Miller PropositionsNoLeverage 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

$1million

and operate in a perfect capital market. Also, for both firms the required return on assets,

rA, is

7.5%

and the risk-free rate is

2.5%.

b. Recalculate the values. For both firms calculate the total firm value, market value of debt and equity, and required return on equity. assuming that the market mistakenly requires a return on equity of

11%

for Leverage.

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

b1. If the market mistakenly requires a return on equity of

11%

for Leverage, the market value of Leverage's equity is

$