MM without Taxes Companies U and L are identical n every respect except that is
ID: 2782409 • Letter: M
Question
MM without Taxes Companies U and L are identical n every respect except that is unlevered while L has S9 million o 7% bonds outstandng. Assume that ) there are no corporate or personal taxes, all of the other M assumptions are met, (3) EBIT is $1 million, and (4) the cost of equity to Company U is 10%. a. What value would MM estimate for each firm? 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. Company U Company L million million 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. e. Suppose Vu $20 million and VL $22 million. According to MM, are these values consistent with equilibrium? -select-Explanation / Answer
a) VU = EBIT/ rSU = $1 million/0.10 = 10 million VU = VL = 10 million Firm U 10 million Firm L 10 million b) Firm U = r sU = Given 10.00% Firm L = r sL = r sU + (r sU- r d )(D/S) = 10% + (10% - 7%)($9/$1) 37.00% c) Amount in millions Firm U Firm L No Debt Some Debt EBIT $1 $1 Debt $0 $9 rd NA 7.00% rs 10.00% 37.00% Interest $0 $1 Value of Stock = (EBIT - Interest)/ Cost of Equity $10 $1 Total Market Value of Firm = Value of Stock + Debt $10 $10 Value Of Firm $10 $10 millions d) Firm U WACC 10.00% Given Firm L WACC = 7% x $9/$10 + 37% x $1/$10 10.00%
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