Problem 21-7 MM with Corporate Taxes Companies U and L are identical in every re

Question

Problem 21-7
MM with Corporate Taxes

Companies U and L are identical in every respect except that U is unlevered while L has $20 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 $4 million, and (4) the unlevered cost of equity is 10%.

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.

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.
%

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

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.
%

Company U $   million Company L $   million

Explanation / Answer

Working:

Value- Unlevered firm $ 24 Million Levered firm $ 32 million

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