Question

eBook MM with Corporate Taxes Companies U and L are identical in every respect except that U is unlevered while L has $8 million of 5% 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 $4 million. (4) The unlevered cost of equity is 10%. a. What value would MM Now estimate for each firm? (Hint: Use Proposition 1.) Enter your answers in millions. For example, an answer of $10,550,000 should be entered as 10.55. Round your answers to two decimal places. Company U: $ million Company L: $ million 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 $10,550,000 should be entered as 10.55. 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.

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Answer 1

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- 2x Σ AutoSum : A Fill 2 Sort & m Find & 2 Clear Filter Editing Select Cells LK LL 390 393 394 28.8 PV, FV, ANNUITY (Autosaved) - Microsoft Excel (Product Activation Failed) File Home Insert Page Layout Formulas Data Review View Add-Ins % Cut Calibri -11AA = = = Dr Wrap Text General Ea Copy Paste Format Painter B I U - D A Merge & Center $ - % 8. Formatting as Table Styles Clipboard Font Alignment Number Styles LD404 LB LCD LE LG LH LI 388 mm approach with taxes 389 value of unlevered firm = EBIT(1-t)/ro 391 COMPANY U: value of unlevered firm = 26 [4*(1-0.35)/0.1] 392 value of levered firm = value of unlevered firm + debt*tax rate COMPANYL: value of levered firm = 26 +8*(0.35) = 395 less : value of debt = 396 value of equity 397 398 COMPANY U: O = rs = 10.00% 399 COMPANY L: rs = r0+ (ro-rd)(D/S)(1-t) 400 rs = 10% + (10%-5%)(8/20.8)(1-0.35)= 401 402 EBIT 403 less : INTEREST 0.4 [8 X 5%] 404 3.6 405 tax 1.26 406 net income 2.34 407 value of equity = 20.8 [2.34/11.25%] 408 N CAP STRU VALUE profit margin loan with points LOCK BOX DILUTION DOLLAR COST AVG EXPONPER APR CPI ear FVA pva Rea ferences 20.8 11.25% 4. EBT R 52 53 STATE 56 57 58 | EH . 59 54 si I] 120% - * 10 ENG 0 (+) DOR 20-11-2019

PV, FV, ANNUITY (Autosaved) - Microsoft Excel (Product Activation Failed) Review View Add-Ins File Home Insert Page Layout Formulas Data - 2x % Cut Dr General -11AA = = = D A Wrap Text Merge & Center Σ AutoSum : A Fill 2 Sort & m Find & U - 8. Insert Delete Format $ - % Number Conditional Format Formatting as Table Styles Cell Styles 2 Clear Filter Editing Select Font Alignment Cells LD LE LE LG LH LI LK LL EBIT less : INTEREST ЕВТ tax net income value of equity = 0.4 [8 X 5%] 3.6 1.26 2.34 20.8 [2.34/11.25%] Calibri E Copy Paste Format Painter B I Clipboard LD401 LB LC 401 402 403 404 405 406 407 408 409 410 411 412 413 414 415 416 417 418 419 420 421 HIN CAP STRU VALUE Rea ferences value of levered firm = value of equity + value of debt value of levered firm = 20.8 + 8 = 28.8 it tallies, GREAT, see answer in "a" WACC COMPANY U: WACC =r0 = 10.00% COMPANY L: WACC =rs*(S/V) + rd*(D/V)*(1-t) WACC = 11.25%* (20.8/28.8) + 5%*(8/28.8)*(1-0.35) WACC = 9.03% profit margin loan with points LOCK BOX DILUTION DOLLAR COST AVG EXPONPER APR CPI ear FVA pva 52 53 STATE 56 57 58 59 BO 54 si 120% _ DOR . * 10 ENG 20-11-2019