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

ID: 2803381 • Letter: C

Question

Companies U and L are identical in every respect except that U is unlevered while L has: $10 million of 5% bonds outstanding.

Assume that:

(1) All of the MM assumptions are met.

(2) Both firms are subject to a 40% federal-plus-state corporate tax rate.

(3) EBIT is $2 million.

(4) The unlevered cost of equity is 10%.

Questions:

a. What value would MM now estimate for each firm? (Hint: Use Proposition 1.)

b. What is rs for Firm U? For Firm L?

c. Find SL, and then show that SL D VL results in the same value as obtained in Part a.

d. What is the WACC for Firm U? For Firm L Please how Excel syntax/formula for answer

Please show Excel syntax/formulas

a. Estimate for U = EBIT*(1-tax rate)/ Cost of equity = 2,000,000*(1-0.4)/0.10 = 12,000,000

Estimate for L = Unlevered value + Tc * D = 12,000,000 + 0.4*10,000,000 = 16,000,000

b. Rs for U = Cost of equity = 10%

Rs for L ; = Ru + (Ru - RL)*D/E = 10% + (10%-5%)*10/(16-10) = 18.33%

c. We do not know what is SL D and VL. Please desribe what these terms mean

d. WACC for U = Unlevered cost of equity = 10%

WACC for L = 10/16*5*(1-0.4) +6/16*10 = 4.125%

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