Task: Use the appropriate MM model to evaluate the following: an unlevered firm (Firm U) has a market value of $45 million, a tax rate of 40%, and expected EBIT of $9 million. A levered firm (Firm L) is identical to Firm U (same tax rate, same EBIT) except Firm L has outstanding 8% debt of $18 million.
Q1. The weighted average cost of capital for Firm U is
Q2. The cost of equity for firm U is
Q3. The weighted average cost of capital for Firm L is
Q4. The cost of equity for firm L is
Q5. The market value of Firm L is
e. $ 9,000,000
Q6. Has Firm L benefited from the use of leverage? Why or why not?
a. Yes because VL > VU
b. No because VL > VU
c. Yes because rAL > rAU
d. No because rAL > rAU
e. In fact, only answers (a) and (c) are correct