Companies U and L are identical in every respect except that U is unlevered whil

Question

Companies U and L are identical in every respect except that U is unlevered while L has $8 million of 7% bonds outstanding. Assume that (1) there are no corporate or personal taxes, (2) all of the other MM assumptions are met, (3) EBIT is $1 million, and (4) the cost of equity to Company U is 10%.

b.What is rs for Firm U? Round your answer to two decimal places. % What is rs for Firm L? Do not round intermediate calculations. Round your answer to two decimal places. %

c.Find SL. Round your answer to two decimal places. Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. $ million

d.What is the WACC for Firm U? Round your answer to one decimal place. % What the WACC for Firm L? Round your answer to one decimal place. %

Explanation / Answer

(1) rs for U company will 10 % because it is using only equity whereas company L is using only bond as per data given in the question so there will be no rs.

(2) SL for U company = EBIT / Cost of equity

SL = 1000000 / .10 = $10 million.

SL for L company will be same as in the case of U company because there is no tax. Thus SL for L company is $10 million.

(3) Again I repeat that as per data given in the question company U uses only equity so WACC will be 10% while company L uses 7% bond only so WACC for company L will be 7%.

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