MM with Corporate Taxes Companies U and L are identical in every respect except
ID: 2791874 • Letter: M
Question
MM with Corporate Taxes
Companies U and L are identical in every respect except that U is unlevered while L has $10 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 12%.
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.
______%
MM with Corporate Taxes
Companies U and L are identical in every respect except that U is unlevered while L has $10 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 12%.
What value would MM now 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. (Hint: Use Proposition I.) Company U $_____ million Company L $_____ millionWhat 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.
______%
Explanation / Answer
a) VU = EBIT/ rSU = $3 million/0.12 = 25 million VU = VL = 25 million Firm U 25 million Firm L 25 million b) Firm U = r sU = Given 12.00% Firm L = r sL = r sU + (r sU- r d )(D/S) = 12% + (12% - 6%)($10/$15) 16.00% c) Amount in millions Firm U Firm L No Debt Some Debt EBIT $3 $3 Debt $0 $10 rd NA 6.00% rs 12.00% 16.00% Interest $0 $0.60 Value of Stock = (EBIT - Interest)/ Cost of Equity $25 $15.00 Total Market Value of Firm = Value of Stock + Debt $25 $25.0 Value Of Firm $25 $25 millions d) Firm U WACC 12.00% Given Firm L WACC = 6% x $10/$25 + 37% x $15/$25 12.00%
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