MM with Corporate Taxes (PLEASE NOTE THAT NUMBERS ARE DIFFERENT THAN IN TEXTBOOK
ID: 2760442 • Letter: M
Question
MM with Corporate Taxes (PLEASE NOTE THAT NUMBERS ARE DIFFERENT THAN IN TEXTBOOK)
Companies U and L are identical in every respect except that U is unlevered while L has $18 million of 6% bonds outstanding. Assume that (1) all of the MM assumptions are met, (2) both firms are subject to a 35% federal-plus-state corporate tax rate, (3) EBIT is $3 million, and (4) the unlevered cost of equity is 13%.
A. What value would MM now estimate for each firm? (Hint: Use Proposition I.) Enter your answers in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answers to two decimal places.
B. What is rs for Firm U? Round your answer to one decimal place.
________ %
What is rs for Firm L? Do not round intermediate calculations. Round your answer to one decimal place.
________ %
C. Find SL, and then show that SL + D = VL results in the same value as obtained in part a. Enter your answers in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Do not round intermediate calculations. Round your answers to two decimal places.
SL = $ ________ million
SL + D = $ ________ million
D. What is the WACC for Firm U? Do not round intermediate calculations. Round your answer to two decimal places.
________ %
What is the WACC for Firm L? Do not round intermediate calculations. Round your answer to two decimal places.
________ %
Explanation / Answer
Value of the firm U in Million EBIT $3.00 Less : Interest $0.00 EBT $3.00 Less : Tax 35% $1.05 Earning after tax $1.95 Value of Firm U $15.00 Value of Firm L 15 Million + (18 Million bonds*.35) $21.30 WACC of L = Ko = Ke*S/V + Kd * D/V = 13*15/21.3 + 6*6.3/21.3 = 9.16+1.77 = 10.93% WACC of U = Ko = Ke*S/V + Kd * D/V = 13*15/15 + 0*0/0 = 13 = 13.00%
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