Un-Levered Co. and Levered Co. are two identical companies in all aspects except for their capital structures. Un-Levered Co. is an all-equity financed company, with total market value $600,000. Lever Co. uses both stock and perpetual debt; Yield-to-maturity of the debt is 9% and coupon payments in each period is $18,000. Both companies generate EBIT of $75,000. Assume no taxes, and lending rate = borrowing rate.

1a) What are the market values of Levered Co.s debt and equity (4%)? What is the debt-to-equity ratio of Levered Co. (1%)?

An investor can generate exactly the same cash flows and ROE as holding $45,000 of Un-Levered Co.s stocks by lending money at interest rate of 9% and investing in the Levered Co.s stocks (i.e. homemade un-leverage).

1b) What is the ROE of Un-Levered Co. (1%)? How much should the investor lend out and invest in Leveled Co. stocks (2%)? Demonstrate how the investor can generate the same cash flows and ROE as holding Un-Levered Co.s stocks (5%).

Now suppose that there is tax rate of 30% and Un-Lever Co. has 10,000 shares outstanding. Further assume that the company wants to increase level by issuing the 9% yield perpetual debt with coupon payments $18,000 in each period, and uses the money to buy back some existing shares. The company still generates EBIT $75,000.

1c) What are the market values of the debt and equity of Un-levered Co. after issuance of the debt (6%)? What is the final share price (2%)? How many outstanding shares remain (2%)? (Assume the company can buy back non-integer numbers of shares.) Other things being equal, it is good for a company to borrow money, and why (2%)?