Problem 21-7 MM with Corporate Taxes

Companies U and L are identical in every respect except that U is unlevered while L has $18 million of 5% bonds outstanding. Assume that (1) all of the MM assumptions are met, (2) both firms are subject to a 35% federal-plus-state corporate tax rate, (3) EBIT is $2 million, and (4) the unlevered cost of equity is 10%.

What value would MM now estimate for each firm? (Hint: Use Proposition I.) Enter your answers in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answers to two decimal places.

Company U	$____ million
Company L	$____ million

B. 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. _____%

C. 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 $1.2 million should be entered as 1.2, not 1,200,000. Do not round intermediate calculations. Round your answers to two decimal places. S_L = $ _____million S_L + D = $_____ million

D. 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. ____%