Rahman Co. has an expected EBIT of $120,000 in perpetuity and tax rate of 40%. The firm is paying 8.75% interest for $210,000 outstanding amount of debt. Unlevered cost of capital is 11.75%.

1. Evaluate the firm using Modigliani and Miller approach (Case (II), Proposition (I) with taxes)?

(4 marks)

2. Find the equity value and D/E ratio?

(1 mark)

3. Under the Modigliani and Miller approach (Case II, Proposition I with taxes), explain how the firm can increase its value using the financial leverage? And explain the reason behind that?

(2 marks)