U Corporation has an EBIT of $975,000 per year that is expected to continue in perpetuity. The unlevered cost of equity for the company is 14% and the corporate tax rate is 35%. The company also has a perpetual bond issue outstanding with a market value of $1.9 million.

a. What is the value of the company if M&M propositions hold? (5 marks)

b. The CFO of the company informs the company president that the value of company is $4.5 million. Is the CFO necessarily wrong? Explain using the tradeoff model. (4 marks)