Problem 17-6 MM without Taxes Companies U and L are identical in every respect e
ID: 2790189 • Letter: P
Question
Problem 17-6
MM without Taxes
Companies U and L are identical in every respect except that U is unlevered while L has $9 million of 7% bonds outstanding. Assume that (1) there are no corporate or personal taxes, (2) all of the other MM assumptions are met, (3) EBIT is $3 million, and (4) the cost of equity to Company U is 12%.
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.
%
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
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.
%
Suppose VU = $20 million and VL = $22 million. According to MM, are these values consistent with equilibrium?
-Select-Yes / No
Problem 17-6
MM without Taxes
Companies U and L are identical in every respect except that U is unlevered while L has $9 million of 7% bonds outstanding. Assume that (1) there are no corporate or personal taxes, (2) all of the other MM assumptions are met, (3) EBIT is $3 million, and (4) the cost of equity to Company U is 12%.
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 $ million Company L $ millionWhat 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.
%
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
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.
%
Suppose VU = $20 million and VL = $22 million. According to MM, are these values consistent with equilibrium?
-Select-Yes / No
Explanation / Answer
Question - 1
Value of the firms
Company U ............EBIT / Cost of equity = 3 million / 0.12 = 25 millions...............final answer
Company L ........ Stock value = (EBIT - Interest) / Cost of equity = ( 3 millions - 0.63) / 0.12 = 19.75 million
Debt value = 9 million
Value of company L = 19.75 + 9 = 28.75 ..................final answer
Question - 2
rS = Return on stock
Company U ..................12% ( as given in question)
Company L ................( EBIT - Ineterest) / Stock value * 100 = 2.37 / 19.75 * 100 = 12 %
Question - 3
SL = Stock value in levered firm = 19.75 million
Question - 4
WACC
Company - U .............. 12 % ( as given )
Company - L .................. EBIT / FIRM VALUE * 100 = 3 / 28.75 * 100 = 10.43%.................final answer
Question - 5
NO
Because, the value of the two firms are not same. Through the process of arbitrage, they will reach equilibrium value.