Question 2 (15 marks) Jeff Dougherty, Chairman of the Board of Mil & Mod Incorporated, wishes to know how a change in capital structure would affect the value of the firm's equity and the firm's weighted average cost of capital. Currently, Mil & Mod is an all-equity firm and expects EBIT to be around $151.52 million per year in perpetuity. The company currently pays a marginal tax rate of 34% and the unlevered cost of capital is 20%. Dougherty is trying to calculate the impact of a $500 million increase in debt, which can be obtained at an interest rate of 10%. Required: (a) Using M&M proposition I with taxes, calculate the value of the firm and its equity after including debt. (5 marks) Using M&M Proposition II with taxes, calculate the value of the firm's cost of equity capital and the firm's WACC. (b) (c) (5 marks) Using pecking-order theory, explain why companies prefer internal financing over external forms of financing. (5 marks) TURNOVER