Question 5 (22 Marks)

Company A and B have the same business (operating) risk with EBIT of 10,000$ pa (perpetuity) but B is levered with 15,000$ of perpetual debt @ 5% interest rate. As unlevered cost of equity is 10%. The market value of Bs equity is 72,000$. Corporate taxes are 30%.

1. (3 marks) What is the levered cost of equity for B?
2. (6 marks) Assuming MM are correct, what should Bs levered cost of equity be?
3. (4 marks) Draw a graph of % return vs D/E ratio to illustrate your answers in (a) and (b).
4. (6 marks) Show how MM would make risk free profits.
5. (3 marks) What is the WACC, assuming MM are correct? Check your answer.